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NFLX (Part 1): An Expensive But Stunning Media Powerhouse

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**Part 1 is meant to be an informal assessment of NFLX based on observations and through discussions with people, without precise statistical data.

Thesis:

  • A pure online media tech play with an extremely strong moat
  • Still has a lot of potential for massive growth
  • Valuation is sky-high in the traditional sense – but consider this Charlie Munger’s quote

Most everyone’s heard of Netflix – even if you’ve never used their streaming services.

It’s a commonplace name today – thanks to its overwhelming success and phrases like “Netflix and Chill” (which totally means a whole ‘nother thing, by the way).

Savvy investors have caught onto this success early on, with its shares skyrocketing over the last couple of years.

So… what is it they saw that we didn’t?

A Strong, Defensible Moat

It is becoming clearer now that Netflix is not just another online media/entertainment company serving up shows and documentaries. It successfully outcompeted similar services like Hulu, Sling TV, HBO Now and Youtube TV because it had a couple of existing competitive advantages under its belt.

First, it has an extremely powerful network effect of loyal subscribers. You might wanna fact check this – but I believe Netflix has significantly way more subscribers to its platform than the next best competitor (which I believe is Amazon Prime Video). These subscribers are in a demographic where they don’t bat an eyelid forking out $14.99 a month (not sure how much it is, actually) for good quality entertainment. Netflix knows this. And this is evident from its recent price hike announced mid-January. Shares kept on going higher – and likely, there was no significant loss in subscribers as well. Contrast this with Hulu, which announced a drop in its basic plan from 7.99 to 5.99 USD a month… just days after Netflix’s announcement. Netflix is a powerhouse – and its competitors know it cannot possibly compete directly with Netflix in terms of pricing. This demonstrates one highly sought-after quality in a Buffett-like investment: Pricing Power.

READ:  NFLX (Part 2): An Expensive But Stunning Media Powerhouse

Second… well this is a continuation of the first point because I can’t stress this enough – but Netflix has employed this subscription-based business model so effectively – that it essentially creates a barrier to entry for other players. Having dabbled in a bit of digital marketing myself, the subscription-based model works extremely well for a library-style offering – where a subscription allows you access to a whole gamut of benefits/products/services that you can never finishing consuming. This can be seen in Spotify (overtaking Apple music), Amazon Prime (2-day shipping benefits on millions of products), and even the initial idea of DollarShaveClub (refills sent monthly due to the short lifespan of blades). Moreover, the largest benefit of this model is that it is easily scalable. The benefits/product/services are all there in a library-style fashion. Everything is set up once. There is none-to-little marginal cost of bringing more subscribers on-board to access those offerings. The benefit for us as investors is a significantly large (and increasing) gross margin as more people use the services (and spread out the costs of acquiring licences, etc..) This translates into more Free Cashflow for investors, which means a higher (and growing) intrinsic value in the long run.

Third, Netflix acts as an all-too-important distribution (profit) channel for BOTH the film producers and TV networks. TV networks rely on Netflix for a good portion of licencing fee revenue (which incentivizes them to produce more good quality shows). This is an increasingly important source of revenue as mainstream TV appeal plummets even lower and ad revenues aren’t making up for the costs of production. In effect, TV networks “depend” on distribution services like Netflix to attract eyeballs for their shows. Also increasingly, more and more independent film producers are looking to media companies like Netflix to distribute their shows, rather than old-school cinemas or DVDs (btw, Netflix also has a DVD-arm which is quite profitable too). With the rise of Netflix Originals, this becomes more apparent. The Black Mirror series is one good example. The franchise was bought over from Channel 4 (UK) after it was outbidded. According to reports, Charlie Brooker stated that “somebody didn’t just come out and wave a cheque and we ran away from Channel 4 towards it”. This seems to suggest that Netflix could provide filmmakers a much freer creative space (with significantly larger profit potential) than a traditional broadcast network could have.

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One counter-argument I was asked: What about new entrants like Disney and NBCUniversal? They both have strong backing and horsepower to take on Netflix…

The beauty of such businesses with an extremely strong (and sustainable) moat is that even the big players cannot effectively or directly compete with Netflix (largely because of Netflix’s network effects and brand loyalty/familiarity among its millions of users worldwide).

Technology Isn’t A Moat

So far all the competitive advantages I have shared have little-to-no relation to “innovative technology” or “disruptive tech” or whatchuma’ call it.

Tech in itself – is not a moat. However, tech can CATALYZE the creation of a moat. This is why I don’t consider Tesla to have a moat. Or Snap Inc. Or Twitter.

What makes one tech company sustainably more profitable from another tech company is not because of better technology. It’s due to certain other factors (which could be driven by technology) such as key patents, network effects, etc, etc…

The combinations of multiple such characteristics give a tech company its sustainable competitive advantage – not the technology itself.

I will discuss this in more detail in another post. For now, stay tuned for Part 2.

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