Years ago, before Amazon had become the internet's 800-pound gorilla, many Wall Street analysts and journalists viewed the company with extreme scepticism. I worked for Fortune magazine at the time, and we were among the doubters.
Our rationale was sound. Amazon's earliest product categories-books, movies and videos-were seeing a decline in revenue. It cut deals with a handful of companies that wound up going out of business. Even after the dot-com bust, its stock was overvalued by traditional measures. And most telling of all, because founder and chief executive Jeff Bezos was so insistent on plowing every spare penny back into the business, the company made no money. In one particularly biting 2001 story, we concluded that Amazon "will never be the high-growth, wildly profitable, super-efficient company of Internet lore." Ouch.
What brings this to mind is the cover story in the new issue of Barron's. The subject is Netflix, a company that Barron's views with, well, extreme scepticism. The headline reads: "Cash-burning Netflix is vulnerable as Disney shies away, Amazon looms, and Facebook muscles into video. Shares could fall 50%."
Like Fortune's analysis of Amazon, Barron's came to its conclusions after a forensic examination of its numbers.
The author, Jack Hough, noted that Netflix's cash burn this year would be between $2 billion and $2.5 billion, and that it is financing its spending "with junk-rated debt." At $171 a share, its stock price is very high, even though its profits are minimal. It is spending an enormous sum this year-$6 billion or so-licensing and creating content. (By comparison, HBO will spend about $2 billion this year on content.)
Although Netflix now has over 100 million subscribers worldwide, its subscriptions don't cover all of its costs, which raises the question of what will happen if the company ever raises its prices significantly. Would that cause subscribers to abandon the service, which would cause the stock to drop, which would make it harder to get the debt-financing it relies on?
Meanwhile, The Walt Disney Co. recently announced that it would move the movies and TV shows it currently licenses to Netflix to its own streaming service after next year, movies that include such hits as Moana and Finding Dory. Amazon continues to ramp up its own streaming service; its content budget is now in the range of $4.5 billion. And Facebook is playing around with a new video service. These are all fearsome competitors, with geometrically more revenue than Netflix.
Finally, Hough reminded Barron's readers that, for all the attention Netflix's own content gets, most of the movies and TV shows it streams are licensed from other content providers. Other companies, many of which fear Netflix and wish they had never "enabled" the company by licensing its shows, could follow Disney's lead and decide to stop making content available to Netflix.
(Some, like Discovery Communications, already have.) Or content could simply become too expensive if Netflix stops gaining new subscribers and can no longer spend so freely.
"Investors will care in a hurry if membership gains slow or stall," Hough wrote.
"Growth depends on content, and for companies that don't own much of it, content requires cash. Netflix runs the risk of getting shut out of attractive content in coming years if its buying power wanes." Hence his view that the stock could drop 50 per cent.
I have to say, there is not much in the Barron's story that you can easily refute. The scenarios Hough lays out are definite possibilities; there is good reason some of the smartest investors on Wall Street are short Netflix's stock. Nonetheless, I think the skeptics are going to turn out to be wrong, just as they were with Amazon.
The key factor that the critics overlooked with Amazon was the skill and determination of Bezos. Though it wasn't yet clear-perhaps not even to Bezos-what Amazon's ultimate business model was going to be, we know now that his drive, his ingenuity and his clear-eyed focus on customers saw Amazon through various rough patches until the company emerged as the retailer every other retailer fears, on pace to generate nearly $170 billion in revenue this year. The skeptics' focus on Amazon's balance sheet caused them to overlook the cultural attributes that Bezos instilled in Amazon that made it unstoppable.
In Reed Hastings, Netflix has a similarly focused CEO. Hastings, 56, has been running Netflix since he co-founded it 20 years ago. In its earliest incarnation, sending DVDs to customers through the mail, Netflix vanquished a much bigger competitor, Blockbuster.
In 2007, at a time when Netflix's DVD business was highly profitable, Hastings began the company's streaming service, potentially cannibalising its DVD profits. Though it streamed only movies at first, Hastings and his number two, Ted Sarandos, realized that the real opportunity lay in streaming hour-long television dramas-thus allowing the networks and studios to, in effect, syndicate hour-long shows just as they traditionally did with half-hour comedies.
Although so-called "video streaming on demand" rights generated significant revenue for the companies that licensed their shows to Netflix, many of them came to resent Netflix's power, and see it as a threat to the cable bundle, which remained the largest source of their profits. To help ensure that it remained in control of its own destiny, Netflix began creating its own content with shows like "House of Cards," which streamed its first season in February 2013, and "Orange is the New Black," which followed five months later. In other words, every time Hastings reached a fork in the road, he took the right path, even if it was the riskiest.
In the fall of 2015, I got a peek inside Netflix as the company prepared for another big Hastings-inspired gamble: a plan to expand the service to the entire world (aside from China). Although Netflix was already in 60 countries, each had had its own rollout, usually with shows in the native language, and lots of marketing hoopla. This time, there would be very little of either, at least at first, and there were plenty of people who thought this was a misguided idea that would lead to losses and chaos. Yet today, less than two years later, Netflix's international subscribers have overtaken its domestic ones, 56 million to 53 million.
I wound up thinking that no matter what happens as television evolves, Netflix will be one of the winners, along with HBO, Amazon, and a handful of others. I say that not just because of what Hastings and the company have already accomplished.
It is also because of what I saw at Netflix. Hastings has created a culture of excellence, where civil disagreement is encouraged and internal politicking is the surest way to get fired. It has the kind of healthy paranoia that Andy Grove instilled long ago at Intel-it is constantly looking over its shoulder, assessing the landscape and the competition. Days after Disney said it would end its relationship with Netflix, the company fired back by signing Shonda Rhimes, who created "Grey's Anatomy" and "Scandal" for Disney's ABC unit. Finally, Hastings may be the smartest CEO I've ever met.
The point is, the things I saw that caused me to believe Netflix is going to come out a winner are not things that you can find in a balance sheet or an income statement. All the potential issues aired by Barron's are real. But sometimes there are companies where the numbers don't tell the full picture. Netflix, I believe, is one of those companies.
Just as Amazon was long ago.