Netflix: Stick or twist?
October 24, 2013
Netflix is an emblematic company; emblematic of the starkly simple fact that ubiquitous fast access is rewriting the rules of pay-TV. The California company does what ‘traditional’ players like Showtime and HBO do, but does it with an aggressive price and complete control of its marketing and – in most respects – its distribution.
This means it doesn’t need to cut carriage (i.e. revenue sharing) deals with distributors who control its consumers, and it doesn’t get bundled in with less attractive content – i.e. it isn’t used as a bribe – or a battering ram if you prefer – to get a load of old toot into subscriber’s homes.
Reed Hastings and his team have exploited these benefits brilliantly to build a US subscription base that equals that of the gold-standard HBO. It is also expanding rapidly internationally. An impressive set of results this week saw its stock rise and medium term stock price targets lifted again.
So why did Carl Icahn sell half his large stake? The simple answer is a 400%+ profit yielding around $800m. But Icahn isn’t short of cash, he’s been making a very lot of money for a very long time. Now styled an ‘active investor’, as if an altruistic representative of suppressed shareholders, thirty years ago Icahn was a prominent member of the Corporate Raiders club. He was one of the original ‘Barbarians at the Gate’, and often accused of buying into a target stock merely to start takeover rumours, then selling out as the price rose.
Latterly – as regulations were changed to discourage blatant arbitrage – he has proved an astute investor, often for the long term. So why get out of a go-go stock that’s still going? Especially as his two key investment managers, including his own son, have made it clear they disagreed with the divestment.
Icahn says it is merely prudent to sell, take an impressive profit, and reduce Netflix’ overweight position in his portfolio. But clearly he must also see the same flickering warning lights that a handful of analysts have also pointed to. Essentially it comes down to basic economics and common sense:
- Supply and demand. Netflix can only increase market share and margins if it can compete on content quality. That takes money to either buy it or make it. Netflix is doing just this and, so far, its content bets – particularly in original production – have paid off. But as anyone in that business will tell you, it’s a percentage game; you will get turkeys, and some of them will be really expensive. Meantime, the price of proven good content will only move one way; up and up and……
- Competition. Netflix has parlayed one beautifully simple idea – send DVDs in the mail don’t have expensive shops – into another; send people DVDs down the line. And it has reaped the benefit of that originality and being a super agile first mover. But no one gets to keep an idea that good to themselves. New players, most notably Amazon, are chasing and, probably more dangerous, established players like HBO know they must change their business model to level up the field. And those players really know how to play the content game.
Netflix has proved an astute enough player not to be overly fazed by changing market conditions – although it did make that crass pricing gaffe a year ago – and it will doubtless continue to successfully grow. But will it grow as profitably as it current stock price targets imply? That’s the question for professional investors and, like the pro he is, Icahn had hedged his bets. His managers were so disappointed they insisted on new contracts, meaning their bonuses would track the sold stock as well as what remains in the portfolio. Wouldn’t it be ironic that if at bonus time, a takeover rumour meant Netflix shares doubled and Icahn senior had to not only reflect on his missed profit but also pay out double bubble to his boy?