Chuck has a healthy respect for the short-term prospects of Netflix (Nasdaq: NFLX ) , yet he's turning a blind eye to the bigger opportunities here. He says that we're looking at a "great transitional business model, but absolutely no long-run moat." Again, Wal-Mart (NYSE: WMT ) gave up because the distribution system wasn't there, and Blockbuster's (NYSE: BBI ) legal department can tell you about the intellectual-property moat that Netflix has built around itself.
Furthermore, it's not trivial to build up the kind of studio relationships Netflix has in place. The company has a 40-person department in Beverly Hills that does nothing but talk to the big studios all day long. Through revenue-sharing deals and long-standing relationships with every major film studio, Netflix has done the groundwork necessary to hammer out on-demand and online delivery deals, and the technology is already in place.
The existing movie selection and recommendation systems will form the foundation for the new-media efforts, and it's just a matter of bringing the content producers around to allowing new delivery formats for their material. Netflix is starting with art-house and indie studios that have much to gain and nothing to lose. And if you build it (and show that it can be profitable), they will come. I believe that Netflix is in a better position than anybody else to profit from the video-on-demand revolution, whenever it comes.
As for the slowing revenue growth rates, my esteemed colleague decided to focus on the exact worst-case period. Of course Netflix grew like a weed before there was any competition, and of course Wal-Mart's and Blockbuster's entry into the market slowed things down a bit. A 2005 price war with Blockbuster Online was magnified by the need to keep Amazon.com (Nasdaq: AMZN ) on the sidelines. As a result, 2005 was really a miserable year for Netflix. But take a look at what's happening now:
|Quarter Ended||Total Revenue Growth
Over Previous Year
Revenue growth hit rock bottom last summer and is now coming back strong. And as for the churn-rate concerns, most of that comes from customers who sign up for a free trial and don't stick around to pay for the service. Call it a marketing cost and move on. Cancellations of paid subscriptions are rare.
Netflix is improving revenue growth, lowering churn rates, and defending its deceptively wide moat with vigor. It's in the nature of Rule Breaking that the shares seem overpriced by traditional measurements, and I'd argue that P/E ratios don't apply to a company that can double its net income simply by lightening its ad blitz a smidgen. The only real risk you're running is to be left behind when the market catches up to the genius of the Netflix model. I respect Chuck's decision to watch from afar, but I'm in for the long haul.
Netflix and Amazon.com areMotley Fool Stock Advisorselections, and Wal-Mart is aMotley Fool Inside Valuepick. Netflix is also an honoraryRule Breakerthese days.Take your favorite Foolish investing service for a free, 30-day trial.