This Is No Digital Media Bubble

Digital media pundit Dan Rayburn knows a lot about the market he covers, and he's not afraid to tell you so. But even the greatest of analysts gets the occasional call wrong, and I believe I just caught Mr. Rayburn with his foot in his mouth.

Delicious, no?
In a recent blog post, Rayburn says that Netflix (Nasdaq: NFLX  ) , (Nasdaq: AMZN  ) , Akamai Technologies (Nasdaq: AKAM  ) , and other media technologists are all caught up in an excited market frenzy not unlike the dot-bomb bubble of ten years ago. Rayburn:

Today, just about any company involved or associated with streaming movies or TV shows over the Internet seems to have valuations that we haven't seen in quite a few years. While there is nothing wrong with being excited about what's taking place in the market and the growth we are seeing in digital content consumption, many have now set expectations for these companies that simply can't be achieved.

There is no doubt that digital is growing, but online video is not replacing cable and streaming movies are not replacing DVDs today, or any time soon. Seismic shifts like that don't happen overnight or over a few years but rather usually over a long period of time, measured by a decade or more. To put it in perspective, Netflix has only been streaming for three years and while they have been the hands down leader, DVDs and cable TV are still around in volume. (emphasis mine)

We could argue all day about the promise of digital media or the rate at which online movie streams and direct downloads are replacing cable TV and DVDs, but I'll leave all that for another day. What really raises my hackles about Rayburn's argument is the way he "puts it in perspective."

Let's put it right back, then
Let's compare the current situation to the rise of the DVD format, shall we? In 1997, the first DVD players went on sale in America. Three years later, American consumers snapped up about 100 million DVD discs at retail for about $1.9 billion as part of the quickest technology ramp ever witnessed. But VHS tapes still ruled the rental racks. Five years after that, Best Buy (NYSE: BBY  ) and Wal-Mart (NYSE: WMT  ) had stopped selling tapes. The changing of the guard was complete.

If each of Netflix's 15 million subscribers stream a full movie every other month or so, Netflix is already ahead of the growth rate of the DVD medium in 2000. That's just one company, albeit the clear leader in the space, versus the ghost of an entire industry. It's a better story this time.

Been there, done that
Mr. Rayburn, we've been here before. Our Foolish founding father David Gardner first recommended Netflix to his Stock Advisor subscribers back in 2003, only to back out again six months later with a nice 160% return on the investment. CEO Reed Hastings had lost David's trust by aiming too high when he declared and ambition to become "one of the world's leading media companies" in 10 to 20 years.

That ambition is still alive and well on its way to fruition. The streaming success is not an overnight surprise but the result of a long and deliberate plan. And we've ain't seen nothing yet: Just as the DVD medium didn't explode until Sony (NYSE: SNE  ) introduced the PlayStation 2 as the first truly capable, affordable, and multifunctional DVD player, Netflix is building toward a critical mass right now.

And all signs point to the company signing flat-rate licenses with the studios rather than paying a fee per view; for example, the Epix deal has a definite price tag and not a guesstimate based on expected customer usage. Netflix is also very tight-lipped about actual streaming traffic, but would probably have to disclose that one way or another if its expenses depended on that volume. And finally, it just makes economic sense. More subscribers with a relatively fixed cost structure means more profit, and that appears to be exactly what Netflix is shooting for.

So with all due respect, I have to disagree with Dan Rayburn this time. Stock Advisor has re-recommended Netflix five more times since that sell order in November 2003, with returns ranging from 498% to 1,147%. The company would have felt right at home in our home-run-seeking Rule Breakers service where Baidu, the strongest of many fine stocks recommended, stops at a mere 1,144% return to date. And I believe the best is yet to come.

Follow Netflix or any other stock by adding it to My Watchlist.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. Best Buy and Wal-Mart Stores are Motley Fool Inside Value recommendations. Akamai Technologies and Baidu are Motley Fool Rule Breakers picks., Best Buy, and Netflix are Motley Fool Stock Advisor choices. Motley Fool Options has recommended buying calls on Best Buy. The Fool owns shares of Best Buy and Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.

Read/Post Comments (8) | Recommend This Article (15)

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  • Report this Comment On September 29, 2010, at 3:55 PM, jrmart wrote:


    I just got notified that my Apple TV that I ordered on September 1, 2010 is on its way to me. I will use the Apple TV to replace my Nintendo in order to stream High Definition NetFlix movies to my TV.

    I just love the NetFlix/Apple combination.

  • Report this Comment On September 29, 2010, at 6:30 PM, maximus9 wrote:

    Looking at the financials of Netflix and Amazon, I think the suggestion of 'bubble' may have some merit after all. Price/Book value of Netflix is 47 times compared to Amazon at 12 times. Amazon revenue is 28+ billion whereas Netflix is tiny 1.88 blln.

    NFLX might have become too pricey and could burn investors getting in at this point. Shares are already at an all time high and slightest bit of bad news could bring it down to earth. Could make more sense to wait for pullback on both stocks or if already invested take 50% off the table - booking profits never hurts !

  • Report this Comment On September 29, 2010, at 10:55 PM, maximus9 wrote:

    It is interesting to note that the mighty titans like Apple and Google trade at just 6 times and 4 times of book value respectively. These giants are sitting on mountains of cash: Google has 30B and Apple holds 24B cash, with zero debt. Forward P/E: AAPL=16.24, GOOG 16.85, AMZN= 65.83 and NFLX=69 !

  • Report this Comment On September 30, 2010, at 2:45 AM, fposter wrote:

    NFLX stock is being bid up as if it owns the future of movie streaming! Unlike the DVD mailing business where it can claim its proprietary technology gives an operational advantage, NFLX will be at a disadvantage going forward. Content? NFLX does not have any! The movies studios own them. At best, nflx will be able to license them at the price the cable companies get them. The cable companies, on the other hand, also have content they produce themselves. Streaming infrastructure? anyone can do it -the cable guys also have the advantage here as they own the pipe that carries the content. Nflx customers still have to pay somebody, the cable company in many cases, for that pipe. As for reports that nflx is currently leading in movies downloading, that could simply reflect the fact that current broadband is yet fast enough to make movie streaming worth paying for(nflx customers downloading for free, the reason for its reported lead). With competitive disadvantage going forward, chased from behind by low cost competitor( Redbox), this stock is a bubble waiting to burst! The demise of Blockbuster could ironically mark the begin of the end for nflx.

  • Report this Comment On September 30, 2010, at 5:15 AM, TMFZahrim wrote:


    Actually, Netflix has some direct deals with smaller studios now:

    Not as impressive as signing Disney or Sony, to be sure, but every journey of a thousand miles and all that. The cable (Epix, Starz) deals are just an intermediary step and will probably be cancelled when the big studio contracts start happening.


  • Report this Comment On September 30, 2010, at 1:38 PM, CFischer wrote:

    To the above posters: I think NFLX is fully priced at current levels, but I don't think Price/Book is a good metric to judge these companies. I think Price/projected FCF is much more relevent. I also agree with FPoster: I don't see where Netflix has any competitive advantage in distributing movies electronically. You need speciality hardware and they don't own the pipe.

    Anders, since it seems every article you write has the aim of dispelling any possible notion that NFLX could be fully, in not overvalued, I'm wondering what level you do think it is fully valued at? I can't really tell, since you never seem to talk about projected revenue, costs, earnings, growth rates, etc., and instead seem to focus your analysis on anecdotal facts about the company and how much the stock is up since the Gardners first recommended it..

  • Report this Comment On October 04, 2010, at 10:28 PM, TheDecider wrote:

    I don't understand how you can try to deny a bubble without addressing the issue of valuation. Makes no sense.

  • Report this Comment On August 03, 2011, at 10:19 AM, rafarules wrote:

    amen to the last two comments.

    intel and cisco market cap-wise is still far below their lofty levels from over a decade ago. their revenues are higher and have risen quite a bit - probably more than double what they were in 1999. Their valuation is lower, less than half.

    it's foolish not to address the short term popularity contest that has propelled these companies to insane valuations not justified by discounted cash flows which ultimately prevail in the long run, which is a weighing contest - not a popularity contest.

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