Netflix CEO Hastings Defends Company's Lofty Stock Price in 2,000 Word PostTuesday, December 21, 2010, 11:24 AM ET|Posted by Will RichmondNetflix CEO Reed Hastings isn't being shy about his company's soaring valuation, posting a 2,000 word defense on the Seeking Alpha blog. The relatively unusual move comes in response to an earlier post by investor Whitney Tilson explaining why the stock is due for a decline in 2011. The two men are friends and joint backers of charter schools. Hastings says somewhat tongue in cheek up front that his "desire is to increase (Tilson's) odds of making money next year so he can donate even more to the charter public schools that we both think are important to our country's future."
Tilson's main point is that given Netflix's huge stock price run-up in 2010 and its move into streaming, the company's stock is poised for a fall. The chief reasons he cites are: new competition from well-funded players like Amazon, Apple, Comcast, etc; escalating costs of acquiring streaming content rights which in turn will drive down Netflix's margins; a comparatively weak content selection today; risk that the market is already saturated providing little room for growth; higher bandwidth/delivery fees as ISPs grapple with an onslaught of streaming use; and uncertainty over the "First Sale" doctrine which allows Netflix to buy DVDs once and rent them continuously. When you see the list itemized this way, and with the quantitative support that Tilson offers, even the most avid Netflix bull will likely pause.
While Hastings allows that Tilson only has to be right on one or two in 2011 to make money with his short sale, he asserts that odds are he's wrong on all of them. The biggest risk he acknowledges is the emergence of a strong new competitor(s). But for them to have an impact, they need to have a differentiator such as better price or more content. Further, Hastings believes Netflix's edge is its "brand/subscriber-evangelism" which makes it less costly for Netflix to acquire new subscribers. (I'd add that Netflix's DVDs are also key because they offer far more selection than streaming will for a long while. The combination of choice, convenience, and low-price is really what makes Netflix tough to compete with.)
Hastings also acknowledges that Netflix's content costs have increased and will continue to. However, he notes that no content is a "must have" and therefore if the costs get too high relative to Netflix's ability to maintain margins, then it will simply cut back on content acquisition, leading to a dilution if the service's quality and subscriber growth rate. The emphasis on margin protection will no doubt hearten investors short term (putting pressure on Tilson's short position), but the question does beg - what happens if a large majority of quality content gets outside of Netflix's willingness to pay, but not of others like Google or Amazon for example? Does Netflix's service begin to look materially less competitive, and wouldn't slowing subscriber growth cause similar downward pressure on its stock price?
Regarding Netflix's streaming content quality, Hastings rejects Tilson's analysis that it is sub-par, arguing that in fact the company's huge subscriber run-up is due to its content selection. Hastings points out that Tilson's mistake is trying to compare what's available in Netflix's $8/mo service with what's available in traditional pay-TV services for $80/mo. Customers are realistic; they don't expect everything. And unlike Time Warner's CEO Jeff Bewkes assertions, there are many cases where consumers are willing to accept "good enough" instead of "gold-plated." I think Tilson makes a further error by comparing Netflix to pay-per-use services like iTunes and Amazon VOD where each movie costs $3.99 or more. The pay-TV industry has proven over the years that consumers like a "pay one price/watch all you want" model. Even if the content is superior with iTunes or Amazon VOD, the model is inferior and isn't a valid comparison.
Lastly, Hastings doesn't see content delivery costs rising in 2011 due to broadband ISPs increasing their fees, and in fact sees delivery costs decreasing (btw, if that doesn't undercut Level 3's accusations against Comcast, what does?). As long as Hastings is right, Netflix's shift to streaming will continue to produce huge cost savings that the company will plow into content acquisition.
The Hastings-Tilson debate sets the stage for what is going to be an interesting 2011 for Netflix. The 2 points that Tilson makes which I most strongly agree with are around increased competition and rising content costs. As I said in our recent 2011 Trends webinar, Netflix's biggest issue is going to be reckoning with its own success. The debate will only intensify as the year unfolds.
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