Netflix’s evolving business
When Netflix, Inc. (NASDAQ:NFLX) was founded in the late 1990s, the company was built on single-rental DVDs by mail — in effect, the standard Blockbuster model applied to the Internet. Later, Netflix decided to switch to a monthly subscription plan, and the company began to take off.
In a piece titled “How Netflix (and Blockbuster) Killed Blockbuster” Rick Newman details how the success of Netflix, Inc. (NASDAQ:NFLX)’s subscription model, combined with Blockbuster’s own shortcomings, drove the once-dominant movie renter into bankruptcy.
However, the most amazing thing about Newman’s piece is how outdated it is. Despite the fact that it was published less than three years ago, Newman gives only a passing mention to Netflix’s streaming ambitions. Today, Netflix is known primarily for its streaming, with its DVDs-by-mail dying a slow death.
But that streaming business is shifting
Now with video streaming as its dominant business, Netflix, Inc. (NASDAQ:NFLX) is working to transform what, exactly, that streaming entails. Three years ago, Netflix’s streaming content was nothing but a hodgepodge of various old movies and television shows from a variety of networks and studios — really, anything Netflix could get its hands on at a reasonable price.
At $8 per month, Netflix’s content was a great deal for anyone looking to binge. But of course, there are limits to that strategy. Why, for example, would someone with a robust cable package bother to sign up for Netflix, Inc. (NASDAQ:NFLX)?
Netflix is working to change that. The company has been rolling out original programming, and its clear that three years from now, Netflix will look more like an alternative cable network — except on the Internet.
Much more original content is in the works
In its letter to investors, Netflix, Inc. (NASDAQ:NFLX) spoke at length about the company’s ambitions for its streaming service — specifically, it’s all going to be about original or exclusive content from here.
In February, Netflix released the first season of House of Cards. Unlike other networks, which will typically show only one episode per week, Netflix opted to release all 13 episodes at the same time.
Some consumers took advantage of this, binge viewing all the episodes within a few days, then promptly cancelling their membership. Yet, according to Netflix, the number of people who did this was relatively small — only 8,000. Netflix contends that the media buzz and consumer satisfaction this strategy generated made up for any free-riders.
In addition to House of Cards, Netflix recently released horror thriller Hemlock Grove. Two other new shows will follow this year, along with a fourth season of Arrested Development (a show that last aired on Fox nearly seven years ago) and a second season of Netflix’s first original show, Lilyhammer.
There’s also an animated kids series coming at the end of the year, and a Sci-Fi thriller late in 2014. But it isn’t just about Netflix original content; the company is also working to secure exclusive rights to content from other providers.
In its letter, Netflix writes, “As we continue to focus on exclusive and curated content, our willingness to pay for non-exclusive, bulk content deals declines. At the end of May we’ll be allowing our broad Viacom Networks deal for Nickelodeon, BET, and MTV content to expire. We are in discussions with them about licensing particular shows but have yet to conclude a deal.”
Could Amazon.com, Inc. (NASDAQ:AMZN) and HBO foil Netflix’s plans?
The biggest threat to Netflix’s attempts to re-imagine itself remain Amazon.com, Inc. (NASDAQ:AMZN)’s Prime Instant Video and Time Warner Inc. (NYSE:TWX)’s HBO. Yet, both remain hindered.
Netflix addresses Amazon in its shareholder letter, noting that of its top 200 videos, only 76 are also available on Amazon Prime — up from 75 last quarter.
More generally, while Netflix’s mention of Amazon.com, Inc. (NASDAQ:AMZN) shows that the company views it as its biggest rival, Amazon Prime is weakened in the sense that the service isn’t really a true Netflix competitor.
That is to say, Amazon’s ambitions for Prime are fundamentally different than Netflix’s. To Netflix, the ultimate aim is to get more subscribers. But Amazon’s goals are much larger; Prime is a way to get people to buy more stuff from Amazon itself.
In addition to streaming video content, Amazon Prime also includes free two-day shipping on goods purchased from Amazon.com and free digital book rentals from the company’s vast lending library. In effect, Amazon Prime is really the service for people who love Amazon, not a true standalone Internet video service.
Amazon.com, Inc. (NASDAQ:AMZN) briefly tested Prime monthly memberships last fall, but ended the test after only two weeks. With no mention since, it seems likely that Amazon will continue to keep Prime a service that requires a big, upfront membership fee — a fee that might depend more on the cost of shipping rather than the cost of content.
For its part, HBO remains wholly owned by cable giant Time Warner Inc. (NYSE:TWX). Because of this ownership, HBO is hindered in the strategies it can employ against Netflix.
Specifically, although HBO may only cost $10-$20 per month, that fee must come on top of an already larger cable bill. While Netflix may cost a subscriber only $8, the real fee for an HBO subscription could be over $100 per month.
There have been rumors that HBO is considering offering its online service, HBO Go, to non-cable subscribers, but for the time being, those reports remain only rumors. Further, while HBO has superior original content to Netflix, it lacks the depth of Netflix’s content catalog.
Consequently, even if HBO was to completely sever its dependence on the cable providers, there would likely be few Netflix subscribers that would bail on Netflix for HBO.
Interestingly, the more valuable Netflix becomes, the more valuable HBO becomes to Time Warner’s shareholders. Right now, Netflix is worth about $12 billion. If HBO were to be spun off from Time Warner Inc. (NYSE:TWX), it could be worth at least as much as Netflix, and possibly far more.
Invest in Netflix?
But is Netflix worth investing in? With a price-to-earnings ratio over 600 (more than 30 times greater than the S&P 500) it’s hard to consider buying shares, at least from a fundamental perspective. What’s worse, as Zerohedge notes, the company is facing immense content liabilities.
Still, the company continues to be uniquely dynamic, shifting business models completely every few years. That kind of creativity could keep Netflix relevant for the foreseeable future.
The article Netflix Is Completely Changing Its Business Once Again originally appeared on Fool.com.
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