This Is Netflix's Secret Weapon

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Thank you for joining me for this third in a series of articles outlining my long-term bull case for video content provider Netflix (Nasdaq: NFLX  ) . On Monday, I discussed the information advantage Netflix enjoys over its competitors, by knowing exactly what type of video content its customers watch. Yesterday, I discussed why I believe content costs aren't the problem many think they are, given Netflix's ability to spend the majority of its revenue on content it knows people will watch.

Today, I'll discuss how Netflix focuses on one type of content delivery, using its information advantage and spending ability to concentrate on pleasing its customers.

Rerun TV
Yesterday, I mentioned that a CEO of another company had characterized Netflix as "rerun TV." While that remark may not have carried the best of intentions, Netflix has turned around and embraced it. As it turns out, rerun TV is very popular.

For instance, are you familiar with the late-night programming on Viacom's (NYSE: VIA  ) (NYSE: VIA-B  ) Nick at Nite? Nothing but reruns. I remember watching old Dick van Dyke Show and Alfred Hitchcock Presents episodes on that back during graduate school. The channel's been around for more than 25 years.

Furthermore, go to any video store and see how many old shows and movies are on sale, and then stop to think about what fills a lot of TV programming. I think watching an old, favorite series or movie satisfies some human need for comfort within us. Netflix understands that very well.

In other words, Netflix doesn't need to have the freshest content right when it comes out. It's not playing in that space. And the company has proved that it can be very successful while focusing on a broad catalog of movies and prior-season television.

There can be more than one
Many people seem to believe that there can be only one successful model for streaming video. Actually, the opportunity is so broad that there can be several, as Netflix itself has acknowledged:

  • Advertiser-paid free: YouTube, Hulu
  • Pay-per-view: Apple's (Nasdaq: AAPL  ) iTunes, (Nasdaq: AMZN  ) , Vudu
  • ISP-paid subscription: ESPN3
  • "Free" with expensive cable/satellite/telco subscription: Time Warner's (NYSE: TWX  ) HBO Go, part of TV Everywhere
  • Consumer-paid subscription: Netflix, Hulu Plus, Amazon.

People get sports from ESPN3 or cable subscriptions. They get new-release movies via pay-per-view or by going to the theater. They get "free" content on television or online, but in return, they have to watch advertisements. On Hulu Plus, subscribing doesn't eliminate the ads. On Amazon, streaming video is a benefit of Amazon Prime membership, but not the primary reason to choose that option.

Netflix doesn't want to fit every model. As I mentioned in yesterday's article, the company says it wants to offer content "so broad, engaging and affordable that everyone subscribes," no matter what other kinds of media those customers also consume.

Right now, subscribers seem quite happy with that idea. According to a Synovate survey run at the end of 2010, 34% of respondents cited Netflix as the site most used for watching video content online, ahead of YouTube (18%), iTunes (16%), Amazon (13%), and Hulu (10%).

Make it easy
The Internet represents the future of video. Netflix recognized this a long time ago, and it's been moving aggressively toward making streaming as seamless as possible for viewers.

The company has integrated Netflix streaming capability onto a mind-boggling assortment of devices, including nearly all computers, all iPads, all iPhones, game consoles, Blu-ray players, and nearly every Internet-ready television currently being sold. From a recent presentation: "Soon, nearly every TV sold anywhere in the world will have built-in WiFi and Netflix." It even has a Netflix button on some remote controls!

For another thing, the company makes the customer experience so satisfying that people are willing to pay its relatively low monthly fee, even if they also pay for cable or watch YouTube. One big part of this is the recommendation engine, which suggests content people might never have heard of and would probably enjoy. Amazon has used a similar engine to great effect to sell more stuff.

That dedication to the customer will help propel Netflix forward, and it's one reason why Jim Cramer said recently that viewers in Europe "want Netflix bad."

Come back tomorrow, when I present the final part of my four-point Netflix bull case.

Amazon, Apple, and Netflix are Motley Fool Stock Advisor selections. Alpha Newsletter Account LLC has bought puts on Netflix. Motley Fool Options has recommended a bull call spread position on Apple, and the Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days.

Fool analyst Jim Mueller owns shares of and has an option position in Netflix, and he owns shares of Amazon and Apple. He works for the Stock Advisor newsletter service. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool's disclosure policy is never messed up.

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  • Report this Comment On April 27, 2011, at 11:19 AM, CMFSoloFool wrote:

    No matter how you slice it, Netflix is priced for perfection. Their profit margins are razor thin, and they have growing competition, as one would expect in a technical, wired, advancing Internet age.

    A company with a $160M income and a market cap of over $12B has a lot of very high expectations baked into the price. P/E is currently north of 77, and P/FCF is north of 100. Consider also their debt ratio of over 80%, and you have a recipe for disappointment if even the slightest thing goes wrong.

    New investors should be aware of the associated risk involved in taking new positions in this company.

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