Is Netflix the Next Amazon.com?

If you bought Amazon.com (Nasdaq: AMZN  ) shares in the fall of 2001, you're sitting on a better than 2,200% return today. Nice.

But you know what came just before that mind-blowing bull run? A 90% price drop in a matter of just 18 months. Mr. Market left Amazon for dead when the growth story was just beginning.

Sure, that's an extreme example. Amazon's bounce off rock-bottom came after the dot-com bubble imploded, followed by 9/11 putting another heavy lid on investor enthusiasm. The pioneering e-tailer saw triple-digit sales growth rates slowing down to just 13% in 2001, and it still hadn't figured out how to turn a profit on those rollicking revenues. Those issues are long gone as Amazon once again boasts 40% year-over-year revenue growth by force of habit and made $3.1 billion of operating cash in the past four quarters.

Investors who saw through Amazon's temporary weakness and anticipated the future megagrowth have been richly rewarded. Our own Foolish empire was built on that kind of forward-thinking analysis by Tom and David Gardner. Even in the midst of the bursting bubble, the Gardners stuck to their guns on Amazon. The company was also one of the very first additions to the Stock Advisor scorecard and has yielded a 1,040% return since then. Grab a free 30-day trial pass to our flagship newsletter to follow Amazon's story over the past decade.

So what?
I'm not bringing Amazon's history up out of nostalgia. I think it's an important business pattern to keep in mind when you're reading recent criticisms of Netflix (Nasdaq: NFLX  ) , like today's downgrade by analyst firm Needham.

The firm just reiterated its sell rating on Netflix. "In its effort to drive subscriber growth, Netflix has spent what some would regard as recklessly to acquire streaming content," says the research note.

Sound familiar in the Amazon context? It should. Amazon's stated strategy in the early days was to "get big fast." Judging by recent growth numbers, those early days are still going on. Netflix is walking down the same hypergrowth path, as fast as the company can manage.

CEO Reed Hastings did indeed run a bit too Qwikly last year, which is why a 2011 stock chart for Netflix looks eerily like Amazon's bubble-popping 2000-2001 era. But you gotta spend money now to make money later. Hastings understands this, and Amazon leader Jeff Bezos would agree wholeheartedly.

But Needham might be right!
Needham is an all-star player in our CAPS system and presumably knows what it's talking about most of the time. However, Netflix happens to be the biggest black mark on the firm's otherwise impressive scorecard as Needham stayed bearish throughout the company's swiftest growth period -- and then retreated to a hold near the very top. This way, Needham locked in a negative return relative to the S&P 500.

Needham analyst Charlie Wolf goes on to say that Netflix would be a buy if subscriber growth picks up steam again -- but that it doesn't look likely. The way Wolf sees it, Netflix needs to reduce content costs instead if it ever wants to post another profit. "An acceleration in subscriber growth or a deceleration in the growth in content acquisition costs could trigger an upgrade," he says.

Let's just say that I disagree with the deceleration trigger. The digital video market is still in its infancy, like Amazon's e-commerce retail efforts were in 2001. Taking the cast-iron boot off the accelerator now would be a dramatic change of strategy and a huge mistake. Bezos didn't build an online retail empire by taking the easy way out. Backing down now would relegate Netflix to a bit-player status in the shadows, not the digital-media leader it wants to become.

Want proof? The pudding is in the kitchen.
Netflix critics have this tendency to want their cake and eat it too. Slow down on content acquisition, they say -- but then they decry the allegedly sorry state of the service's streaming library.

Reed Hastings is betting the farm on this rapid growth strategy and is willing to invest billions of dollars in the content weaponry he needs. Amazon or Apple could theoretically dip into their much larger cash reserves to create an instant Netflix killer. But that would be a very inefficient use of cash. Netflix has refined its business model and content partnerships over many years, and not even Apple can match the company's 47% return on capital.

Management has been talking up the return of customer growth, which might even turn perma-bear Needham into a buyer. Netflix reports earnings again in just a few weeks, and the subscriber counts will tell you all you need to know.

The company is shattering records in terms of customer engagement, and I'd be shocked if higher subscriber numbers didn't follow.

Netflix has chosen to follow the Amazon template to online business success, and there are very few role models more worthy than Jeff Bezos. Want to follow this stock story without making a commitment? Just add Netflix to your Foolish watchlist.

Fool contributor Anders Bylund owns shares of Netflix but holds no other position in any of the companies mentioned. The Motley Fool owns shares of Amazon.com and Apple. Motley Fool newsletter services have recommended buying shares of Netflix, Amazon.com, and Apple and have also recommended creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Check out Anders' holdings and bio, or follow him on Twitter and Google+. We have a disclosure policy.


Read/Post Comments (6) | Recommend This Article (5)

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 January 07, 2012, at 12:49 PM, H3D wrote:

    "Is Netflix the Next Amazon.com?"

    No. Amazon is the next Netflix.

    Watch the bubble burst after Amazon's next earnings.

    Netflix lost 79%.

    Amazon's TTM is about to be wiped in half which will give it a P/E of about 200.

    A 79% wipeout will only reduce that to 40. Getting on for 3x as expensive as Apple!

    The market won't let them keep 40. 20 maybe. But that will require a 90% drop.

  • Report this Comment On January 07, 2012, at 1:48 PM, accelerando wrote:

    This is a very silly article. Nflx == Amzn? C'mon guys. Amzn is allowed it's absurd p/e and peg because it SELLS EVERYTHING. No one can even imagine the potential upside. If Amzn can somehow create a moat and hold on to it's % of online commerce to the time when online commerce is almost all commerce, who knows how big it can be. Am very skeptical of the moat -- not sure amzn is the online retailer of choice simply because it offers everything at near cost.

    As to nflx. Are we kidding. The chances of them dominating the video streaming biz five years down the road are fairly small -- even if they do, this is still a modest business when compared to amzn. And they have three competitors -- Appl, goog and amzn, the three most powerful, well run, monster capitalized companies on the planet. Maybe nflx can survive. Maybe they will be bought out. But the most likely scenario is nflx == rimm -- nice try guys. Dominated for awhile. Mediocre management and too many powerful competitors = FLATLINE.

  • Report this Comment On January 07, 2012, at 7:51 PM, oneilmo wrote:

    "Netflix has refined its business model and content partnerships over many years, and not even Apple can match the company's 47% return on capital."

    This statement begs the question. . . Are you high???

    Refined their business model? Try textbook failed strategy and criminally bad financial stewardship.

    How will that return on capital look after the company loses money (as they have forecast) in 2012?

    Get a clue.

  • Report this Comment On January 07, 2012, at 10:13 PM, DaggerSA wrote:

    Comments like the ones above make me wonder is shorters have forgotten that current earnings, current returns on assets, etc. do NOT matter.

    A firm's stock price reflects the present value of the market's perception of all future cash flows. Period.

    Obviously, the market in general believes a turnaround can occur (ergo the comparison with Amazon, who, in spite of negative earnings continue to enjoy increasing stock prices).

    Now, your shorters can choose to listen to the rationale that many have posted here and on other boards, and you can choose to notice the stock is up 20% in 3 days, or you can continue to close your mind on your out-dated rationale for shorting (which mde perfect sense 3 months ago) and smuggly and arrogantly believe you're smarter than the market like so many shorters did with Amazon.

    Go ahead. Sell some more shares.

  • Report this Comment On January 07, 2012, at 10:15 PM, DaggerSA wrote:

    PS Pardon my typos. I'm typing on a tiny notepad keyboard.

  • Report this Comment On January 07, 2012, at 10:16 PM, DaggerSA wrote:

    PPS "Amazon, who, in spite .... continueD to ... "

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