Netflix, Inc.: Criticism Aside, This Could Actually Justify the NFLX Valuation

If you’ve been reading my column, you know that I’m constantly hammering on Netflix, Inc. (NFLX) stock. In an attempt to be balanced, however, I figured I should present the bullish scenario for NFLX stock.

There’s no denying the fact that, as of right now and probably for some time to come, Netflix is the premier streaming content service. It’s also the only service that actually allows you a massive selection of DVDs to rent. Yes, Outerwall Inc (OUTR) has Redbox, but the selection is very limited.

If you want to watch something, chances are high Netflix has it. That means that loyalty to the Netflix brand is strong, translating into lots of recurring revenue and earnings for NFLX stock holders. That’s likely to remain the case for some time, even in the midst of competitive pressures from other aggregating services and services specifically mimicking the Netflix brand.

That recurring revenue allows NFLX to trade at such lofty levels. Add to this the company’s intent to offer streaming in every country (the first to do so, no less) and you have a pretty compelling growth story.

Netflix: Differentiating Itself From Competitors

This, however, assumes that over time Netflix will be able to decrease its marketing expenses as it captures and retains market share. It also assumes that brand loyalty will allow it to slowly raise prices over time.

A dollar here or there isn’t too bad. Certainly here in the U.S., as long as the offering remains at or below the price point of an HBO subscription, which seems to be the base that most people are willing to tolerate — then price increases can occur over time without too much screaming from users.

While the streaming media giant is burning through cash right now, decreasing marketing expenses and increasing prices should alleviate the cash burn. At some point, Netflix may even go cash flow positive.

That brings us to the notion of original programming and the “long tail” of internet content providers. In case you missed it a few years back, the long-tail concept explains why eBay Inc (EBAY) and, Inc. (AMZN) and Netflix can be so successful. Without carrying inventory, these companies satisfy the niche interests of massive audiences, and make a profit to boot. For example, the early version of Amazon’s book and music business had roughly 40% of revenue coming from the aggregation of all these niches.

So, too, with Netflix, and therefore, with NFLX stock. It’s the aggregation of all the niche titles that Netflix has licenses to that helped launch it to success. Now, however, it seems to be slowly abandoning that model and moving more toward original programming. It is sacrificing existing older content for its audience and letting competitors have it, while spending more of its capital on originals.

This does two things. First, it distinguishes Netflix from most of its streaming competitors. It is moving more in the direction of HBO, where you can only see Netflix programming with a Netflix subscription, which may soon become the same price as HBO, and with the same high quality.

It also builds a Netflix library. The library creation is key, because it allows Netflix to turn around and license its own exclusive programming to other content providers, as it’s done with Comcast Corporation (CMCSA), giving it an additional source of revenue.

That revenue could be gigantic.

So, assuming Netflix stock survives the next few years, we could see its stock justify its valuation with these plans.

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.

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