Thursday, September 23, 2010

How To Spot A Bubble? (So you think you're a contrarian? Part Deux)

In re-hashing my for-profit education stance, I came across another element of being a contrarian: spotting bubbles

Case in point: Netflix- $165/share. Yes, the stock has risen 800% Year-over-year. Yes, I am a subscriber and love the service ( I would cancel cable before I would cancel netflix). The reason I am comfortable calling Netflix a bubble is based upon the level of hubris displayed by Netflix CEO Reed Hastings in a recent interview. Here is an excerpt from the interview with "The Hollywood Reporter",

"THR: American services when they enter the Canadian market typically charge the locals more than they charge stateside. Why the discount for Canadians?

Hastings: We want to provide an incredible value for Canadians, and it's the lowest price we have anywhere in the world for unlimited screenings. And anyone can try it for free for a month. It's pretty addictive.

THR: Are you concerned that American Netflix subscribers will look north and ask for the same discount Canadians get at $7.99?

Hastings: How much has it been your experience that Americans follow what happens in the world? It's something we'll monitor, but Americans are somewhat self-absorbed.

THR: How will you will measure success for Netflix Canada?

Hastings: I'm certain we'll succeed, so it's kind of a matter of degree. We're not quantifying that in terms of subscriber numbers or profitability. What we're focused on is getting out there. We've got to get out on all of the devices, get the word out, and we need to be such a good service that people not only stay with us but rave to their friends about it. "

I'm not so appalled by the fact that he views Americans as ignorant and self-absorbed, as the fact that he does not measure success in terms of subscribers and profitability. It should be no-big-secret that Netflix was cashflow negative under its traditional 3-out-at-a-time plan for $19 (due to high postage and DVD replacement costs) and only turned free-cashflow positive due to its streaming business (subscriber growth exploded under its $9, one-at-a-time, unlimited streaming plan- due largely to lower shipping and dvd replacement costs).

Netflix's existing streaming agreements were priced opportunistically as content-owners failed to envision the subscriber growth that Netflix would generate from being able to stream through newer DVD players/TVs/gaming systems. Unfortunately, those contracts do not run forever and Netflix will find itself in the same difficult position as cable companies in a few years (forced to pay much higher rates for streaming). The difference is, Netflix posesses no major barrier-to-entry or competitive advantage like the cable companies do.....

I am not short NFLX yet, but at $8.3Bln market capitalization (4.4x sales/16x Ebitda) I firmly believe that NFLX shareholders will have a "coming-to-Jesus" moment at some point over the next two years.

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