"Invest in what you know" – so goes the famous quote from legendary Wall St investor, Peter Lynch. In today's digital age, Netflix is a permanent down-time fixture for a large portion of the population, with approximately 1.2 million Kiwis having access to a subscription.
If we've all been following Lynch's advice, it might explain why Netflix has been one of the hotter tech stocks over the past five years, posting dizzying returns of up to 800 per cent in this period.
Despite the fact Netflix has taken off with the New Zealand population, do we really know its business model? Will it be as good an investment in the future as it has been recently? And what are the key points to consider as a potential investor looking to protect yourself against investment risk?
Ask yourself – what do you like about Netflix? Is it the platform itself or the range of content available? For most, the value is found in the selection of shows, which Netflix is constantly looking to enhance with their focus on producing original movies, TV series and documentaries that can only be viewed on their platform. From a subscriptions perspective, this has resulted in stickier users, who are more likely to renew their subscription just so they can watch the next season of Narcos.
Making these exclusive shows, however, requires ongoing significant investment from Netflix - like the US$100m spent on the first season of award-winning favourite "The Crown".
Stickiness of customers is an important characteristic in any business; a repeat customer is always more cost-effective than acquiring a new one. For example, if Xero can keep businesses using its software, it's much better than the aggregate spend on sales staff and marketing required to get a new customer.
While Netflix seems "sticky", as an investor it's worth noting this comes at a price.
Although not as prevalent in New Zealand, Netflix faces stiff competition overseas, and particularly in the United States. Along with traditional cable, they're up against deep-pocketed rivals such as Amazon, Disney and Hulu - driving prices up dramatically when they're looking to purchase licenses to host other content (such as those HBO shows we all love). It's always important to understand the competitive environment of companies you are looking to invest in, as it affects the pricing economy of the industry, and ultimately, their ability to grow.
For instance, a company pioneering a whole new industry, like Kiwi garment rental business Designer Wardrobe, has more competitive pricing power than Air New Zealand - which faces a globally competitive market and is ultimately beholden to oil prices. From an investment standpoint, Netflix may have less room for revenue growth via price increases than it may first appear.
These factors all contribute to the rapid rate at which Netflix is currently burning cash (to the tune of US$287m in the first quarter of 2018) and has now turned to debt markets for additional funding. In order to combat interest costs, as well as the discrepancy between expenses and monthly subscription revenue, Netflix will ultimately have to cut costs – by producing fewer original programs, reducing its range of content, increasing the monthly subscription fee, significantly growing the number of subscribers, or adding additional revenue streams such as advertisements.
Very recently, Netflix trialled quick ads between bingeing episodes – although they have now been removed due to poor viewer response. This is a tough decision for any growth-oriented business – wanting to grow in order to reach a larger audience and be profitable, but in the meantime needing to spend investor cash to reach this vision.
There is no doubting the powerfully addictive platform Netflix has become, from its origins as a mail-order DVD service back in the late 90s - but in terms of an investment case, given the amount of industry pressure and the growth needed to match its current valuation, it's far from a 'certain hit'. Investing in "what you know" is a great starting point, but it goes to show it always pays to take a good look under the hood before taking off.
Bill O'Boyle, head of growth capital at Snowball Effect</strong>