Thursday, January 29, 2009

Netflix: built to last?

In an article this week, Forbes claims to offer a list of 100 companies that will survive the next century. The choices are odd and idiosyncratic: Coca-Cola, Disney, Honda, HP, Intel, P&G, Toyota make sense, but Nestle Oil but not Nestle foods? United Technologies but not General Electric?

They list Dell and not Apple, IBM or Microsoft — presumably because Apple won’t survive without Steve Jobs (even though Dell also did badly without Michael Dell). They list Ericsson — even though 30 years ago it was virtually identical to Northern Telecom, now bankrupt.

Of dot-com era technology companies, Amazon makes the cut, but not Cisco, eBay or Google.

Responding to a great quarterly earnings report, Chris O’Brien this morning raves that Netflix belongs among the latter, if not the former.

After almost a decade in operation, Netflix deserves to be recognized as one of the most successful dot-coms ever.

Many of us may have underestimated not just how innovative this company is, but also how well managed it is. It's pulled off a feat that's too rare among Internet companies by pairing a great, disruptive service with a powerful business model. And it's continued to vanquish each rival even as analysts have fretted that it would stumble with every new challenge.

Even more amazing is that the company appears to be gathering momentum after a decade, a neat trick that fellow first-generation Web icons like eBay and Yahoo could only dream of emulating.
O’Brien praises it for its business model (by which he really means revenue model), its operational efficiencies, and by a dogged focus on one market: the US. (It’s not even in the 51st state, even though it once had plans to go to Canada and the UK.)

In following up O’Brien’s column, it was interesting to note what analysts were saying five years ago:
With 2.2 million subscribers, Netflix showed that the model works. Customers go online to select the DVDs. Providers mail them in envelopes that are re-used for returns. Most plans allow customers to have three DVDs at a time, sending a new video out each time one is returned — with no late fees.

But now, "It's very unlikely that they're going to dominate the market," says Michael Pachter of Wedbush Morgan Securities.

The reason? "There are very few barriers to entry, and companies with deep pockets can get in and make some money," says Marquis Investment Research's Brian Bolan.

As a result, many analysts consider Netflix a takeover play. With a market value of $537 million, and no single shareholder controlling enough votes to block a sale, some say Netflix could be had for under $1 billion.

"If the stock price stays at $10 very long, then Amazon has to buy Netflix," says McAlpine Associates' Dennis McAlpine. "Nothing else makes sense. And if you're (Yahoo CEO) Terry Semel, you're drooling. He'd have all the (online retail) capability that Amazon has. Even (InterActiveCorp CEO) Barry Diller might want it."
Five years ago, Yahoo had a market cap of roughly $30b, but now Yahoo’s stock is half what it used to be and Netflix is up 250% from what proved to be a historic low.

None of this proves that Netflix is Built to Last. But, as O’Brien argues, its progress over the past 5 years suggests that it’s on a better trajectory for the next decade than many of its contemporaries.

Update Friday 8am: Michael Pachter wrote to say that he removed his “sell” rating in September 2007, and upgraded to “buy” in October 2007 when the stock was around $22. He also notes that since switching to “buy”, Netflix is up 60% while the NASDAQ is down 45%.

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