Don't Be Misled in This Valuation

Earlier this week, I wrote a post on my blog in which I pointed out that some companies involved or associated with streaming movies or TV shows over the Internet have valuations that, in my opinion, are being inflated by all the excitement around the subject of streaming video.

In short, they're based on the incorrect impression that streaming movies and TV shows are going to replace DVDs or put the cable companies out of business in the near term.

Et tu, Fool
Anders Bylund responded with "This Is No Digital Media Bubble," suggesting that he caught me with my "foot in my mouth." While I appreciate a good discussion on the topic, there are a few things in Anders' article that don't make sense.

For starters, Anders implies that I suggested Netflix (Nasdaq: NFLX  ) , Akamai, and Amazon (Nasdaq: AMZN  ) are overvalued. While I did make that case about Netflix and Akamai, it wouldn't be accurate to talk about Amazon's valuation in that lineup, because today Amazon makes very little money at all from streaming movies and TV shows.

I also argued that, today, digital content offerings from the likes of Hulu, Netflix, Apple, and Amazon are a complement to traditional media. There is no doubt that digital is growing, but online video is not replacing cable, and streaming movies are not replacing DVDs anytime soon. Seismic shifts like that usually happen over a long period of time, usually measured by a decade or more.

Bylund counters that consumers moved quickly from the VHS format to DVDs -- but it's not a relevant comparison. With digital, we're talking about consumers moving to a completely new format that is free of any physical media of any kind. That's very different from comparing the growth of consumers moving from one physical media format to another.

Get ready for a good conversation
Bylund does say that "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." My question is, why wait?

This is exactly the topic we should be discussing, since the growth and adoption rate of digital is one of the major factors that influences the share price of companies in the digital arena. And the great thing about this topic is that we don't have to "argue" about the rate of growth -- we have plenty of data in the market to prove that it takes more than a few years to see consumers replace one kind of media distribution with another.

To put it in perspective, Netflix has already been streaming for three years, and while it has been the hands-down leader, cable TV is not going away anytime soon. Many seem to think that Netflix has changed the industry overnight, but it has taken it more than three years to get even this far.

While Netflix is absolutely having an effect on how content is consumed (and thus is affecting the cable and DVD business), I stick to my argument that far too many investors are using excitement rather than realistic data to value companies. Just this week, NPD released data to show that in the past three months, 75% of all U.S. consumers did not stream or download any multimedia content of any kind.

The bottom line is that the consumption of digital media is growing, it's affecting multiple media industries, and it's very exciting. But one service is not replacing another anytime soon. Even with the positive balance sheets that Apple, Akamai, and Netflix have, one can't let the excitement around streaming movies and TV shows be the major catalyst for valuing them more highly.

Akamai Technologies is a Motley Fool Rule Breakers recommendation. Apple, Amazon.com, and Netflix are Motley Fool Stock Advisor selections. The Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days.

Guest contributor Dan Rayburn is EVP for StreamingMedia.com, a principal analyst at Frost & Sullivan, and is recognized by many as the voice for the streaming and online video industry. He doesn't own any of the companies mentioned here -- or any companies at all, for that matter. 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. The Motley Fool has a disclosure policy.


Read/Post Comments (12) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 30, 2010, at 8:53 PM, loueye wrote:

    Reasons why this valuation is not sustainable.

    There is not enough bandwidth in the world to support the revenue stream necessary justify this valuation.

    NetFlix is riding a subsidy that is sticking in the ISP's craw.. and it will end. NetFlix's model is not proprietary on any level, in fact, they own nothing and rent everything. They rent the content and then they co-opt the bandwidth.

    The streaming content is dated, and does not include the newer releases..

    Quality is videotape level.

  • Report this Comment On September 30, 2010, at 10:44 PM, maximus9 wrote:

    The question is not one of valuation, but the short interest in NFLX. Almost a third of the floating stock is short, and any upward move might trigger a huge short-squeeze, and shares could go through the roof in the short term.

  • Report this Comment On September 30, 2010, at 11:51 PM, Tenderknee wrote:

    Online video has replaced cable for me. I haven't had the latter for six months. I get my Daily Show and Colbert Report fix from iTunes (pass ends up being 50 cents per episode, but it allows me to stream to my TV). For new episodes of other shows, I go straight to the site (NBC, CBS), and older shows I watch through Netflix.

  • Report this Comment On October 01, 2010, at 8:56 AM, TripleEFocus1 wrote:

    Streaming through netflix provides welcome relief from the barrage of advertisement interuptions. The relief is palpable.

  • Report this Comment On October 01, 2010, at 10:13 AM, maximus9 wrote:

    They just don't get Netflix. Game-changing market leaders have always appeared overvalued and Netflix is the undisputed leader in streaming digital content. It represents a paradigm shift in our in-home cinematic habits and experience. The shift will happen much faster than we tend to think and rationalize. It was the same thing with smartphones.

  • Report this Comment On October 01, 2010, at 10:31 AM, bighairydogcat wrote:

    I agree with maximus & Tenderknee. Most people just don't understand streaming. I showed my 50's era parents Netflix and within 2 days they called me to hook up their new Xbox to stream Netflix. They were already paying for the DVD service, but had no idea they could stream. They are both ecstatic.

    I still pay for DirecTv and wondered why when I paid the bill this week. We have not turned it on in over 6 weeks. We seem to find plenty of "dated" material to entertain us. Also worth noting is the iphone app. Simply awesome! I was stuck in traffic, turned on NFLX and watched an episode of American Dad to pass the time.

  • Report this Comment On October 01, 2010, at 10:37 AM, morrisjd wrote:

    Some analysts are missing the demographics aspect of the move to online streaming. If you are Baby Boomer (like me) then you are probably set in your ways and Cable TV and Newspapers are it. But if you consider generation X and generation Y (particularly Y) then it is a different story. Y is open to a lot of seemingly improbable fast happening change. My bet is they will adopt online streaming in the same way that texting and facebook have supplanted e-mail. This will provide the needed critical mass to make streaming the dominant form media distribution to the home environment. And like texting and facebook, it will happen very quickly. Cable will be demoted to a commodity internet port (which is what it's true value is), since their pricing model is too expensive and inflexible in contrast.

  • Report this Comment On October 01, 2010, at 10:55 AM, feldmail wrote:

    Dan, what you're missing in your stats is VOD. While "only" 25% have streamed media, that number is still huge. Still larger, is the fact that this 25% does not include the huge amount of movie watching VOD on cable. The idea that physical disks will be around for years is not learning from history, the fact that DVD wiped out VHS in a few short years.

    With the recent shortening of VOD windows to day-and-date of the DVD release, while extending DVD rental to 28 days later, digital will replace DVD very quickly--at least in the rental market. Studios make MUCH more margin from the VOD, whereas physical rental margin is slim due to first sale doctrine.

  • Report this Comment On October 01, 2010, at 11:39 AM, maximus9 wrote:

    People are typically paying between $45-65 every month for 250-channels cable service. Many of those channels are useless except for some depending on personal preferences. Most analysts accept the fact that NFLX will double its subscription base within a year, yet they are not realizing the value that represents. With limited overheads in streaming service, you are looking at a 3 or 4 time profit multiplier. Stocks like Netflix represent a digital revolution in media and hence tend to operate outside the standard definitions of value.

  • Report this Comment On October 01, 2010, at 11:57 AM, DanRayburn wrote:

    @feldmall: You use the terms like "huge" and "quickly" without defining them. Everyone has a different definition of what "quick" means.

    DVDs launched in 1997. It was not until 2004 that DVDs really killed off the VHS format. That's a span of seven years, which I would argue is not "a few short years" like you suggest.

    Also, DVDs and VHS are physical media formats. Moving from one to the other is much faster and easier than moving from physical media, DVD, to no physical media, digital. So using the VHS to DVD trend as an example is really not relevant.

  • Report this Comment On October 01, 2010, at 12:39 PM, CFischer wrote:

    @Dan: I usually don't listen to brokerage house recommendations at all, but Susquehanna's rationale for their downgrade today more or less sums up my thoughts on the situation, with the exception that I'm not sold that NFLX will double their subscriber base (pick up another 15 Million households) over the next 27 months. I think that is far from a foregone conclusion.

    I'd really like to see what Anders fair value estimate of Netflix is, and how he arrived at it.

  • Report this Comment On October 01, 2010, at 11:29 PM, lowmaple wrote:

    not a technophile but as an aside what company would profit from taping if possible from streaming to DVD or something and will tha hurt or enhance NFLX or whoever may buy them?

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