$300 million to $245 billion in 18 years...Not to shabby
Netflix ($NFLX) went public on May 23, 2002. At the time, they had 600,000 subscribers, and its market cap was around $300 million. Seems crazy, right?
Its business model was simple: For a small monthly fee, Netflix mailed you one or multiple DVDs of your choice.
And the best part…..There were no late fees!
Today, Netflix has 200 million+ worldwide subscribers and its business model hasn't changed at all — except the delivery method. Instead of getting DVDs by mail, you now get shows streamed to your device of choice.
This is the story of how a tiny, DVD-by-mail startup, which Blockbuster could have bought in 2000 for $50 million, disrupted Hollywood and forever changed the entertainment industry.
They say timing is everything...And I think Netflix would agree. Netflix started during the secular shift from VHS to DVD.
They officially launched in April 1998. And at launch, they only had 500 titles to choose from.
Why? Because that was all the DVDs in existence. In fact…In 1999, only 5% of households owned a DVD player.
But in three short years, that figure jumped to 65%. And DVDs became the fastest-growing consumer technology in history.
And during this time, Netflix EXPLODED! The shift to DVDs, and the incumbents' unwillingness to embrace online video rentals, helped Netflix get far enough along that they IPO'd in 2002.
However, it's what happened next that pushed them over the top.
Peering Into the Future...
From 1996 to 2001, telecom companies raised $1.6 trillion from Wall Street and proceeded to jam 80 million miles of fiber optic cable throughout the United States*.
This cable laid the groundwork for not only Netflix's shift to streaming but the modern internet we know today.
Netflix's first hit was House of Cards in 2013. But they were thinking about the shift from DVDs to streaming back in 2004.
From its 2004 annual report:
In addition, we plan to launch Internet delivery of movies in 2005. Our long-term strategy has always been to seize leadership of that new market by building a large subscriber base and offering those subscribers the choice of mail or Internet delivery.
FYI: For a six-year stretch, from 2004 until February 2010, you could buy Netflix’s stock for under $10 bucks.
For six years in a row, Netflix mentioned that consumers preferred getting movies and T.V. shows instantly. However, in its 2005 annual report, it noted two hurdles preventing mass adoption of streaming video over the internet.
- The technical challenge of delivering video over the internet.
- The need for more engaging content.
The answer wasn't obvious at the time. But eventually, both problems were solved.
First, bandwidth increased, which allowed for videos to be streamed over the internet at ever-increasing speeds.
Traditional cable and satellite T.V. companies were caught flat-footed by the shift to OTT (over-the-top). And in the coming decade, they lost millions of subscribers.
In fact, the shift in consumer behavior was so drastic that a new term was coined — "cord-cutting."
Second, Netflix pushed into original content. Its first hit was House of Cards, which premiered in February 2013. One month prior, its stock broke above 20 dollars per share and never looked back. Today it sits at $560 per share.
Both of Netflix's products — first their DVD business, then their streaming business — coincided with technological breakthroughs and shifts in consumer behavior.
Some would say their timing was lucky.
Maybe so, but I would say they were aggressive. And took risks incumbents weren't willing to take. Because incumbents did not want to cannibalize their current cash cow (DVDs) to pursue a new but risky future (streaming).
Netflix’s long-term ambition is not to make a few good shows. Instead, they want to replace your entire TV viewing experience (excluding live shows like sports and news).
And that means making large amounts of content. And most of the content will be average. And that’s ok. Their subscriber base is large enough that one person’s average show is another person’s favorite show. Cable TV enables niche. That’s what makes it great. Lifetime, the Food Network, Hallmark, and History channel. All niche channels created for a specific viewer.
Netflix is recreating this experience. Like the Food channel? Here’s Chef’s Table or the Taco Chronicles. Enjoy cheesy Lifetime movies? Check out Secret Obsession. Thrillers? Yep. Stand-up comedy? Of course.
Not only does Netflix want you to hire them for all your video consumption. They let you do it for a lower price. And that’s the key. Delivering shows you love, and it’s cheaper than cable (the average cable bill is $85. Netflix’s most expensive tier is $17.99).
If they can get you to hire them for your cheesy Lifetime movies and food documentaries, they’ve hooked you. And every minute you spend on their platform, they’re learning more about what you like and what you don’t.
That helps them create an experience so good that browsing Netflix becomes a habit — and sooner or later — that $85 you spend on cable can be put to better use.
How to create hit shows: quality vs. quantity
In 2020, Netflix lost two of its most popular shows — The Office and Friends.
How will Netlfix replace those shows? Those shows are the definition of a Rewatchable.
Let’s go back in history...
The first episode of Friends aired in 1994. The first episode of The Office in 2005. Both were created before Netflix made the jump into original content. Nevertheless, both shows are decade-defining and will command an audience twenty or thirty years after their creation.
What Netflix has been lacking is a decade-defining show, specifically in comedy. A Rewatchable, like The Office or Parks and Rec. A show that will not only attract new subscribers but also keep them from churning. What’s the likelihood Netflix creates a show of that caliber in the next five years?
Another question: What’s the best way to produce high-quality anything? Writing, TV shows, software, whatever?
To answer this question, let’s refer to this story about a ceramics class.
On the first day of ceramics class, the teacher divided students into two groups. The group on the left would be graded on the quantity of the work they produced.
The group on the right would be graded on quality. His procedure was simple: on the final day of class, he would bring in his bathroom scales and weigh the work of the “quantity” group: fifty pounds of pots rated an “A,” forty pounds a “B,” and so on.
However, those being graded on “quality” needed to produce only one pot – albeit a perfect one – to get an “A.”Well, grading time came, and a curious fact emerged: The highest quality works were all produced by the group being graded for quantity.
It seems that while the “quantity” group was busily churning out piles of work – and learning from their mistakes – the “quality” group had sat theorizing about perfection, and in the end, had little more to show for their efforts than grandiose theories and a pile of dead clay.
In other words, the group that took more swings ended up producing the highest quality work.
Despite the worry about Netflix spending gobs of money creating content, they will have taken more swings than anyone.
They will learn from their mistakes, improve, and take another swing. And in doing so, have a fighter’s chance of creating the next decade's defining shows.
And if they can pull that off, wouldn’t you pay more than $18 bucks a month?
The most important question: Is Netflix a good investment at these prices?
Even though I like their chance at remaining the dominant streaming player, I wonder what their ceiling is and how much growth has already been priced in?
Currently, their market cap is ~$240 billion. A double from here would put their market cap at ~$500 billion.
If they double in five years, that’s a CAGR (compound annual growth rate) of 14.87%. If it takes ten, the CAGR is 7.18%. But, unfortunately, those aren’t the growth rates Netflix investors have come to expect.
If their ceiling is $500 billion, is that enough upside to justify a long position, considering there's some chance the bears are right? And competition (hello Disney+), debt levels, and lack of hit shows (specifically around comedy) could stunt Netflix’s growth for the next decade?
Good, even great companies can make bad investments if the price paid is too high😉