Search Results for: netflix

On Monday, Ensemble Capital’s CIO Sean Stannard-Stockton appeared on CNBC to discuss Netflix and the threat of Disney Plus. In this clip, Sean explains why we see Disney Plus as more of a complement than a substitute for a Netflix subscription, and offer an explanation for why Netflix has rallied 17% since Disney Plus launched.


If you are reading this in an email, click here for the video.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

“The son of [Reed Hastings] must not become a Jedi.”

Much to the chagrin of the traditional media Empire industry, Netflix has become the leader of the global direct to consumer (DTC) streaming media (OTT) business it founded with a staggering 150MM subscribers globally. We believe the global scale it’s built up in the business makes it too big for all but a handful of traditional media and global tech companies to compete with. For a more in depth look at its business and strategy, please refer to our deep dive Netflix report.

The market will become much more exciting with the launch of new competitors over the next year, especially offerings from the largest traditional media companies. The new Disney Plus service will launch in November 2019 in the US, Canada, Australia, New Zealand and the Netherlands, with plans to expand globally over the next couple of years. Disney’s DTC service will be followed by Apple’s TV+ and Time Warner’s HBO Max (reboot of HBO NOW plus more TW content) services in soon thereafter.

In our view, the global market is large enough to accommodate 3-5 global media players and many consumers will subscribe to 2 or 3 services offering their favorite content. We believe direct streaming services are redirecting the Pay TV industry’s traditional value chains around the world while expanding the market by leveraging global scale economics and modern low cost distribution via “smart” devices and 4G/5G connectivity.

Having said that, it is important to separate Netflix’s US (maturing) and international (nascent) markets.

“Do. Or do not. There is no try.”

In the US, as the pioneer in streaming video whose odds looked very long only 7 years ago, Netflix has already won. More than half of all Americans subscribe to Netflix, which is more than all the Cable TV subscribers combined (which are in slow steady secular decline). We don’t think there is a ton of growth left in the number of subscribers in the US, especially since a significant fraction share passwords, but we do think Netflix can continue to raise the price they can charge (we also believe password sharing is intentionally leveraged as a viral customer acquisition strategy and, in fact, paid for by its service pricing strategy).

Netflix is already quite profitable in the US, with an estimated operating margin of 25%*. Last quarter they raised the price in the US by 13% and still kept 99.5% of their subscribers, resulting in an 11% q/q increase in net US revenue. You can imagine what that does to enhance profitability given that a substantial portion of the increase falls to the bottom line (profits grew 20% q/q). Compare that with the narrative that “Netflix lost 200K US customers in the quarter, they’re losing their pricing power!”

As we’ve discussed in our post on Netflix’s pricing power, immediately after past price hikes, there have been one or two quarters of increased subscriber churn followed by a bounce back in subscriber growth. The June 2019 quarter was just the latest quarter to see a similar, expected phenomenon though the exact magnitude of the impact is always hard to forecast. We believe the churn is due to initial “sticker shock” and Netflix’s customer friendly policy of clearly alerting people to price increases with a simple button to cancel. But about a quarter or two later, most of these churned-off subscribers hear about a show that all their friends are talking about or realize how wonderful the convenient advertising-free service had been and sign back up, realizing that it is still an amazing bargain at $13/month for essentially a mini-cable bundle offering thousands of hours of instantly on-demand shows and movies.

“I’ve got a bad feeling about this.” 

Investors are quite worried about Disney’s new steaming services, and for good reason, given its well-regarded global brand with strong marketing capabilities, popular IP based video franchises (Disney characters, Star Wars, Marvel, Pixar, etc.), and its multi-year commitment towards global expansion of its streaming services. But Disney is very late to the game and has a lot to learn about going direct to consumer with a subscription business, the execution of which is tougher than most realize. No doubt, Disney will figure this out through years of dedicated experience as Netflix has over the past 2 decades.

“Be careful not to choke on your aspirations, Director.”

After everyone thinking Netflix was bound to fail, the iconic Disney has smartly and humbly realized that their only choice is to try to copy Netflix’s strategic playbook (literally!) to scale quickly and stay relevant in the long run. We believe Disney’s new service is likely to be a big success. But the “product” it is delivering to its subscribers is primarily going to be Disney’s brand of movies and shows. So, it will be more like HBO (a great niche premium channel) while Netflix has a broader set of content akin to an entire cable bundle (a broad selection, cable TV replacement). Disney is hoping that by bundling Hulu with Disney Plus for the same price as Netflix that they can compete directly, but Hulu is not new and has attracted about 30 million compared to Netflix’s 150 million.

That said, it would not be unexpected to see a quarter or two of impact to Netflix’s gross subscriber additions in the US, as a certain proportion of new to streaming video customers give Disney Plus a try, and churn rates to increase, as those Netflix subscribers who value it the least get over their inertia (inertia is a beautiful thing in subscription businesses!) and try a big new competitively priced service instead. A couple of quarters later, we believe we’ll see the playing field become more balanced, with the vast majority of Netflix’s subscribers keeping their service while many of Disney Plus’ new subscribers will be adding it as their second streaming service.

The bigger impact to the entire market will be that the surge of streaming service options, each with its own package of unique content, will finally kill cable television service model. If for $25-40/month you can get Netflix, Hulu, Disney Plus, ESPN Plus and Amazon Prime video, who will keep cable TV? This will free up $100/month of video spending for most households and, while Disney and others will certainly win some of that, we believe Netflix will remain the default service and the de facto leader while the traditional cable companies’ ongoing businesses will be to supply the broadband pipes connecting them.

“The Force is strong with this one.”

Despite its scale and leadership advantages in streaming video, Netflix isn’t sitting still. They are taking their large US profits and reinvesting in dominating international markets where they are far ahead of everyone else. This makes the company look less profitable overall since they grow via income statement spending (outsized content and marketing budgets), not capex as a physical assets company traditionally would have. And though its international business just turned the corner on profitability, we believe it has a long way to grow as the US market has done. Longer term we expect they will raise prices in their international business just as they have successfully done in the US .

At today’s $16/month for their top tier service with four 4K simultaneous streams, people can share the service and pay as little as $4/month each (or subscribe separately to a single mobile stream in some emerging markets like India), which is a bargain for all the billions of dollars of great content they get access to so affordably and conveniently. However, the fixed cost nature of content makes each of even the lowest priced marginal subscribers very profitable and their aggregated spending continues to feed the Netflix content engine that benefits all existing subscribers, even as they scale the add grows the Netflix’s overall margins.

“You can’t stop the change, any more than you can stop the suns from setting.”

So bottom line: we do think competition is ramping up and Disney will be successful, but we never expected that the other media players would fail to compete forever. The fact that they are now recognizing that Netflix has successfully pulled the rug from under their businesses and must be copied doesn’t change our positive view on the company, especially since we believe it is far ahead of the competition on its ability to recruit and retain subscribers, source a variety of locally and globally relevant content, and access deeper into the global market with local partnerships, and most importantly, its culture of customer focus and innovation.

Netflix has already grown to become a global scale media company, so the onus is on the competition to execute and invest billions (in the form of losses for years) in order to do the same to be viable long term competitors.

*Pro forma ECM estimate based on reported US contribution margin and geographically proportionate operating expenses.

For more information about positions owned by ECM on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

Last week, Ensemble Capital’s CIO Sean Stannard-Stockton appeared on CNBC with his take on Netflix’s latest earnings report. During the interview, Sean also explained why we think Disney’s upcoming streaming service won’t be a significant competitor to Netflix despite likely being a big success for Disney.

 

Netflix had a ‘perfectly good’ quarter, investor says from CNBC.

As of the date of this blog post, clients invested in Ensemble Capital Management’s core equity strategy own shares Netflix (NFLX). This company represents only a percentage of the full strategy. As a result of client-specific circumstances, individual clients may hold positions that are not part of Ensemble Capital’s core equity strategy. Ensemble is a fully discretionary advisor and may exit a portfolio position at any time without notice, in its own discretion.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

Will Ashworth at InvestorPlace wrote an intriguing article highlighting 7 companies exhibiting pricing power as a core feature to their business models, including two that Ensemble Capital has owned for client portfolios, Netflix (NFLX) and Apple (AAPL). Pricing power lies at the core of most great businesses — a point often talked about by legendary investors Warren Buffett and Charlie Munger.

In his profile of Netflix, Ashworth quotes our Senior Investment Analyst Arif Karim’s recent Intrinsic Investing post discussing Netflix’s Pricing Power:

“What’s less talked about is the strong pricing power Netflix has shown over the past 5 years since announcing its first price increase in May 2014, growing pricing globally at a 5% clip (7% in the US) since,” Arif Karim, senior investment analyst at Ensemble Capital, stated in a must-read October article in Intrinsic Investing. “Despite this increase in prices, it has continued to show very strong momentum  in signing up new customers for its service around the world.”

Ashworth goes on to note: “Since 2011, Netflix has grown subscribers by 30% compounded annually. In Q3 2018, it increased paid memberships by 5.4% from Q2 2018 and 25% year over year. While the U.S. growth has slowed, international streaming grew by 39% year-over-year with plenty of the world still to cover.”

Netflix’s pricing power has indeed been a topic that has not been discussed much in the public sphere, but one which we believe is an important driver of both the company’s future business strategy (helping fund the build out its moat and global subscriber base) and its future value.

In addition, Ashworth also discusses Apple’s pricing power and offers an apt recent quote from Warren Buffett, who is listed as the second largest owner of company shares [via control of Berkshire Hathaway (BRK/A) as of 6/30/2018]:

“I have a plane that costs me a lot, a million dollars a year or something of the sort. If I used the iPhone — I use an iPad a lot — if I used the iPhone like all my friends do, I would rather give up the plane,” Buffett said on CNBC in August. “Now it’s got competition so you can’t push the price, but in terms of its utility to people and what they get for a thousand dollars…you can have a dinner party that would cost that, and here this is, and what it does for you, it’s incredible.”

Arif discussed Apple’s iPhone franchise, the great utility it offered its users, and its positioning as a luxury brand with pricing power in our discussion about the sustainability of Apple’s iPhone franchise in 2016, when many public discussions were being had about the death of innovation at Apple with a market valuation that reflected those doubts:

“This brings the focus on the well-designed device, its capabilities couched in a simple intuitive interface, its elegance, and the daily needs it fulfills as well as aspirations it can help the user attain. It’s a brilliant strategy that emphasizes the brand and emotion that creates the connection with its users while de-emphasizing the technology that can be threatened by the latest, greatest, cheapest competing gadget… while expensive at a face value of $650-$850, the iPhone and smartphones in general, are the most important and personal discretionary device the consumer owns. They serve as the gateway to your entire digital life that has grown to be a very important part of yourself. It is your most used device and will only increase in importance over time.

And, with a life span of two to three years, the cost of the average iPhone translates to less than $1 a day. This is an incredible value per hour of usage for the average smartphone user in any developed country as well as a significant number of users in emerging market countries. Given how much time owners of smartphones spend using their devices and how important a part of their lives they play, paying up for a premium, more secure, easier to use smartphone is one of the most practical luxuries they can pay for.”

For other great examples of companies with pricing power, we invite you to learn more by reading Will Ashworth’s article posted below.

7 Stocks to Buy for Real Pricing Power

As of the date of this blog post, clients invested in Ensemble Capital Management’s core equity strategy own shares of  Apple (AAPL) and Netflix (NFLX). The company represents only a percentage of the full strategy. As a result of client-specific circumstances, individual clients may hold positions that are not part of Ensemble Capital’s core equity strategy. Ensemble is a fully discretionary advisor and may exit a portfolio position at any time without notice, in its own discretion.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

Netflix’s Pricing Power

18 October 2018 | by Arif Karim, CFA

Netflix (NFLX) has demonstrated a torrid pace of growth since launching its stand-alone streaming video service in 2011, with paying subscribers growing at a 30% CAGR through the end of 2018. What’s less talked about is the strong pricing power Netflix has shown over the past 5 years since announcing its first price increase in May 2014, growing pricing globally at a 5% clip (7% in the US) since. Despite this increase in prices, it has continued to show very strong momentum  in signing up new customers for its service around the world.

Figure 1: Netflix’s Subscriber Growth

Source: Ensemble Capital Management and Netflix, Inc.

We’ve talked in the past about our thesis on Netflix and its powerful moat characteristics.  According to Warren Buffett, the definition of a good business is one that has pricing power. We believe Netflix has it in spades, and expect that they will announce regular price increases over time that will allow revenue to grow faster than subscribers. This is partly the result of its history of being a classic disruptor, offering a “good enough”, low price service to win customers.

However, over time, it has transformed into a great service by leveraging the capabilities of the new medium over which it serves its customers, the Internet for direct distribution and a variety of devices outside the television for consumption of media. In the process, it has increasingly won over large swaths of new customers by being the better experience and investing heavily to build the breadth and quality of its content that has earned it a place next to the longstanding leader in quality content, HBO.

Despite steadily increasing the quality of its service for customers, Netflix’s pricing has lagged the growth of that consumer value leading to the build up of a large consumer surplus. That surplus, or the excess consumer value over the price of the service, is an important factor that has driven such a rapid rate of growth for the service. The bigger the surplus, the better the deal for the consumer. But this also results in a sub-optimal return for the shareholder, at least in the short run, which can look like an inferior business model if you don’t look more carefully.

Figure 2: Consumer Surplus Creation

Source: Ensemble Capital Management

The power of the model is to realize that the consumer surplus represents latent pricing power that can be reallocated via price increases or reinvestment changes towards future profits for shareholders. In Netflix’s case, we believe this is an important lever in managing the rate of its growth and returns. By offering a compelling value proposition to incremental consumers, Netflix drives subscriber growth because it is a fantastic deal at $10/month. The consumer surplus is an investment in Netflix’s rapid growth, an implicit subscriber acquisition expense in the form of foregone revenue and profit, intentionally leveraged to quickly scale so that nearly all traditional media incumbents would be left too far behind when they awoke to the direct to consumer global scale streaming video opportunity. It’s clear at this point that this strategic goal has either been accomplished or nearly has.

Over time, we believe prices can be raised substantially to improve the economics of the business, potentially to the detriment of subscriber growth because it will be a less compelling offer. If the service has stickiness to it (we believe it does), then the vast majority of existing customers are unlikely to churn off as that surplus decreases. The result will be higher prices, higher profits, but slower growth. However, that assumes the value of the service remains constant. In Netflix’s case, by continually reinvesting a substantial portion of incremental revenue into improving the service experience and increasing its catalog of quality content, it is continually increasing the value of the service for all of its subscribers, which plays into a classic network effect moat. When coupled with a content scale moat, it becomes an increasingly tougher barrier for competitors to overcome.

Figure 3: The Netflix Flywheel

Source: Ensemble Capital Management

And that is really the secret sauce to Figure 1 that shows accelerating subscriber additions even as prices have risen over the past 5 years, while Figure 2 shows how consumer surplus can increase even with higher prices for the consumer, so long as value creation rises faster.

Netflix has continually increased the value of its service even as it has asked its customers to pay more, which has maintained its torrid growth rate at a massive global scale with 100MM+ subscribers and forecasted to grow by 28MM subscribers by the end of this year. That is an incremental $4B in revenue in 2018 alone enabling (via cash generation and capital market access) $7B in funding towards additional content, subscriber growth and scaling initiatives, and improved service investments. This also fits another of Buffett’s requirements for a great business, i.e. Netflix is a business that is focused on growing its moat every day. And management has proven itself highly competent in both understanding the levers they  need to command to do so, while also focusing on the right decisions for the business to maximize its value for the long term.

Figure 4: Netflix Cumulative Global Adds by Week

Source: Netflix, Inc.

As Netflix approaches mature levels of growth in specific markets (like the US), we believe it will make a rational shift in both pricing strategy and incremental reinvestment allocations towards a more balanced sharing of the value it delivers between its customers and shareholders, resulting in much greater profitability than is currently observed in reported numbers. To this point, the company has committed to growing its annual operating margin moderately going forward, a position that plays to our view on the strategic trade off between growth, profitability, and pricing while allowing the company to continue investing in maximizing the development and capture of the global long term growth opportunity in streaming video content.

As a simple illustrative exercise of how profitable the business could be if it were to price its service closer to the value it provides its current base of customers, we did a sensitivity analysis of the incremental profitability of average monthly pricing ranging from $15-25 per month:

Figure 5: Theoretical Netflix Price-EPS Normalization

It’s hard to argue that the service isn’t worth more than its current $10/month based on objective data like viewer engagement, content quality and breadth, price-user analysis, and anecdotal evidence. There is a growing proportion of people that are “cutting the cord” in favor of online entertainment choices, the leader among them being Netflix or, as is more often the case in international markets, discovering and signing up to view talked about differentiated original content on Netflix.

Therefore, an assumption that the service’s value to consumers as it currently stands could be worth $15-20/month and growing to $25+ over the next decade does not seem wildly optimistic to us. And if you were to believe that, then paying an average of 20x normalized current earnings for the disruptive runaway leader in the global scale media business, growing over 20%/yr with a long growth runway, scaling moat, and increasing profitability looks reasonable in our view.

As of the date of this blog post, clients invested in Ensemble Capital Management’s core equity strategy own shares of  Netflix (NFLX). The company represents only a percentage of the full strategy. As a result of client-specific circumstances, individual clients may hold positions that are not part of Ensemble Capital’s core equity strategy. Ensemble is a fully discretionary advisor and may exit a portfolio position at any time without notice, in its own discretion.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.