I recently received an email in my glorious gmail account that sparked some quick stock research and may end up being particularly lucrative for me and possibly for you. To go long or to short, that is the question.
Yesterday I saw on my iPhone that Netflix has decided to increase my subscription cost by $3 per month to continue to have access to Blu-Ray discs. Previously, they had charged $1 per month, regardless of how many DVDs your plan entitled you to, and now it is a sliding scale based on your plan. This is extraordinarily counterintuitive, as one would expect for the price to drop as Blu-Ray becomes more common and the price of Blu-Ray discs falls, so I felt it necessary to do a wee lil’ research. I expected to see that the recent economic decline caused Netflix’s performance to suffer as consumers spent less on DVDs and cancelled their accounts. This was not the case.
Upon looking into it a little further, Netflix’s margins have actually increased consistently from 2006 to 2008, with Q4 ‘08 being what appears to be one of, if not the, strongest quarter to date in terms of revenue size and profitability. In a separate discussion with my mother today, she enlightened me as to why this seems to be the case. Instead of reducing DVD rentals, many people are increasing these rentals and signing up for Netflix to reduce the expenditures associated with the traditional date night: dinner and a movie. However, what seems to be happening is these couples will put various DVDs in their queue and then when it arrives one or the other won’t be in the mood to watch that particular chick flick or action movie, so it languishes on their dresser. This, in turn, means that Netflix garners the usual monthly fees, but actually sends out fewer DVDs, thereby increasing their overall margin. And now, they’re increasing their revenue stream from Blu-Ray to further increase margins. Nicely done, from a short term perspective, and this is why I’m now a proud owner of 0.00003% of the company, well primed for my eventual take-over.
The Company is clearly set to grow and, in addition to Blu-Ray, has focused significantly on its on-demand efforts, which will most likely become the key revenue driver in the future. However, currently they have cornered the home DVD market and look well positioned to do again with Blu-Ray, which I expect to be a pretty solid decision given that high definition on demand services will likely take a while to roll out as fiber optics are generally needed to support that sort of bandwidth1,2. The only problem that I have is that they’ve said they wanted to subsidize Blu-Ray by only charging $1 per month to have access to encourage customers to buy Blu-Ray players and rent Blu-Ray movies. But is Blu-Ray really that ubiquitous? Without the PS3, many people wouldn’t have these players and I think it may be a little too early to spring this price increase on everyone, unless they really just wanted the early adopters3 to switch over but then raise their prices before their infrastructure costs declined. This could potentially be genius because you can blame the currently higher prices on the price differential between Blu-Ray and DVD, and as the cost of a Blu-Ray comes down, you can leave the price high to further improve your margins.
Overall, I found it to be an interesting bit of research. Netflix stock has gained something like 40%+ year-to-date while the market has fallen by ~18%, so they must be doing something right. Just a question of whether they can continue to do so. I’m betting they can, but I’m obviously not betting the farm; did that in late 2007 and I was forced to buy all new clothes4. So there you go, a free stock tip. You’re welcome.
Catch you on the flipside5.
1 Or so my limited knowledge, based mostly on speculation and hearsay, has led me to believe.
2 Current HD on demand is limited to pay per view movies and some select movie channels, but I’m not yet convinced that this “HD” is actually Blu-Ray quality. I feel like watching a movie on HBOHD and watching it on Blu-Ray are two very different things, but I haven’t scientifically tested it. Nor do I expect to.
3 Who are, more than likely, Netflix customers and likely have been for years.
4 I lost my shirt, in other words.
5 As usual this doesn’t fit well within my written blog but is necessary for another 2 weeks or so: I got my nightly work out in so that makes four days straight.
