Netflix Approaching Its Apple Moment

Over the past year, Netflix (NASDAQ: NFLX  ) and Apple (NASDAQ: AAPL  ) have traded places in the minds of many investors. A year ago, Apple was a Wall Street darling that was nearing its all-time high above $700, with many analysts predicting a run to $1,000 or higher. Meanwhile, Netflix stock was down in the dumps, trading for as little as $53 -- a far cry from its all-time high of more than $300 in 2011.

AAPL Chart

Apple vs. Netflix 1 Year Stock Performance. Data by YCharts.

As the two companies prepare to report June-quarter earnings this week, Netflix has surged back toward its all-time high, while Apple has been languishing below $450 for most of the year. Yet the two companies face surprisingly similar strategic landscapes, with market saturation posing a potential threat to future growth.

A similar timeline
The recent histories of Netflix and Apple parallel each other in many ways. Today, Netflix and Apple each have one signature product that consumers identify with the brand more than anything else. For Netflix, it's the company's streaming-video service; for Apple, it's the iPhone.

Both of these products were introduced in 2007. However, neither product was fully formed at that time. The Netflix "Watch Instantly" service was just a free perk for subscribers to its DVD-by-mail service, and users were only allotted a certain number of hours of viewing per month. The iPhone was only available through AT&T in the U.S. initially, and the App Store did not even exist until 2008.

In the U.S., the iPhone did not become widely available until 2011, when it finally launched on the Verizon and Sprint networks. By then, the iPhone had received most of the upgrades that differentiate today's iPhone from the original 2007 version. Netflix developed its streaming service at a similar pace. The streaming-only plan launched in late 2010, and in 2011 it was separated from the DVD-by-mail service.

A different perception
Apple's iPhone and Netflix's streaming-video service have been in the market for a similar length of time. Investors have become increasingly worried over the past year that the iPhone has already saturated the market. These fears seem overblown, but given 55 million U.S. iPhone users as of May, it's true that Apple cannot sustain rapid user-base growth in the U.S. for much longer.

Yet comparatively few people seem to be concerned that Netflix may be approaching its own saturation point in the U.S. Indeed, the company is trading for more than 85 times forward earnings estimates, indicating that Wall Street expects the company to post rapid growth well beyond 2014.

Netflix ended Q1 with 29.2 million U.S. streaming subscribers and projected that this would grow to as many as 30 million subscribers by the end of Q2.

This may seem like a much lower market penetration than the iPhone. However, Netflix allows -- and even encourages -- family members to share an account, whereas smartphones obviously cannot be shared effectively. As a result, Netflix's addressable market in the U.S. is, at most, the 115 million households here, whereas there are already 141 million U.S. smartphone users.

If you limit Netflix's addressable market to households with broadband Internet, the market size drops to 88 million households. By that standard, Netflix has already captured 34% of its addressable market, whereas the iPhone has 39% of the U.S. smartphone market, and smartphones overall have 59% of the U.S. mobile-phone market.

So what?
All of these statistics may seem meaningless out of context. The key point for investors is that Netflix's domestic streaming business is just a year or so behind the iPhone in terms of market saturation. Both products entered the U.S. market around the same time, and the iPhone's growth trajectory has been just slightly ahead of Netflix's.

Just one year ago, Apple stock was rocketing higher on the back of high hopes for the upcoming iPhone 5. Today, Netflix stock is rocketing higher on the back of high hopes for its recent foray into original programming. However, just as Apple investors have received a harsh reality check in the last year, Netflix investors are likely to get one in the next year or two as the company approaches saturation of the U.S. market. When the saturation issue comes to the fore of Netflix investors' concerns, the stock could take a long tumble due to its rich valuation.


Read/Post Comments (18) | Recommend This Article (34)

Comments from our Foolish Readers

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  • Report this Comment On July 22, 2013, at 7:28 PM, arboriginal wrote:

    I've owned Netflix since last Summer and we have already taken back all of our principal using a stop. When we stopped out we bought back in with our profits and have ridden it back from $167 a share. We have also been Netflix customers for over 10 years. To read this article you would think the only market this company is developing is the US market. But most of the companies recent growth is from overseas, more than 30%. To leave this detail (not) out is only half the story, so I question the authors motive. Why would you leave out such an important fact. For anyone who follows the company my statement of overseas and Canadian expansion is common knowledge.

  • Report this Comment On July 23, 2013, at 10:55 AM, TMFGemHunter wrote:

    @arboriginal: Thanks for the comment. The U.S. is Netflix's key market, providing more than 100% of profit. The international expansion will hopefully lead to some profit down the road, but it's unlikely to hit breakeven for 2 or 3 more years.

    It's hard to be sure how other people think about companies, but my guess is that if you asked investors to break down the "value" of Netflix into a sum of the parts story, domestic streaming would account for at least 70% of the total value. That's why I focused on that business segment.

    Adam

  • Report this Comment On July 23, 2013, at 11:01 AM, StockGamingCom wrote:

    A P/B of nearly 14 and a P/E of 317. Amazing.

    The market can stay irrational longer than you stay solvent.

  • Report this Comment On July 23, 2013, at 11:22 AM, bigbenjamins2 wrote:

    Some parallels can be drawn, but there is one major difference that renders them almost meaningless: Apple's market cap is $385 billion larger than Netflix's (over 25x bigger). That's means that in order for Apple to post a 10% gain, it has to create, at least from the market's perception, 2.5x Netflixes in value. That's a tall order for any company. Netflix, on the other hand, can create media franchises on a modest scale and still post significant growth even if the subscriber needle doesn't move by building substantial media assets. Netflix got in the media business because someone (Blockbuster) left the back door open. Now that they have busted in they are exercising their squatter's rights big time. Netflix is here to stay, although their revenue model will evolve over time, as it has done in the past. Apple, on the other hand, must revolutionize incredibly competitive industries and disrupt its own business model in order to move the needle just a little.

    I agree that Netflix may have a pull back in the next year or two. Ten years from now I think I will be glad that I was a long term owner of this business, which I believe at that time will be a small media empire.

  • Report this Comment On July 23, 2013, at 12:33 PM, TMFTomGardner wrote:

    BigBenjamins,

    Yes.

    Tom Gardner

  • Report this Comment On July 23, 2013, at 2:08 PM, militauro wrote:

    Tom G. stole my thought, good post BigBenjamins.

  • Report this Comment On July 23, 2013, at 2:19 PM, TMFGemHunter wrote:

    @BigBenjamins: Thanks for the comment. You raise a good point, but it only goes so far. Think of an Apple "subscriber" as somebody who buys a new iPhone every 2 years, a new iPad every 3 years, and a new Mac every 4 years, plus various iTunes/App Store purchases along the way. For every new "subscriber", Apple gets an annual revenue stream of perhaps $800, depending on what features they opt for.

    By contrast, for every new Netflix subscriber, the company gets an annual revenue stream of about $100.

    Apple also has significantly higher margins today, but it's hard to know what the true "incremental" margin is for Netflix, so I'll leave that aside.

    The difference in value per subscriber already explains a substantial portion of the difference in valuation. (Apple subscriber is worth 8 times more annual revenue, and Apple's enterprise value is about 16-17 times higher than Netflix's EV.)

    I would also point out that Apple's enterprise value dropped by more than half from peak to trough (about seven months). So it's not THAT hard for investors to adopt a radically different view of how much value Apple is creating or destroying.

    I also think there's a big question about what a "small media empire" is and how much it is worth. AMC has developed a run of several highly successful originals (some of the most highly viewed content on Netflix, in fact), makes more money than Netflix, but has an EV less than half that of Netflix.

    Obviously, the two have different business models, and Netflix has a lot more viewers than AMC. Still, in my opinion it casts doubt on how much a successful media franchise is really worth.

    Adam

  • Report this Comment On July 23, 2013, at 2:40 PM, marco555 wrote:

    Parallels between Apple and Netflix ? Yes they are.

    Having an Apple TV, a Netflix subscription ,a Cox cable connection to Internet and Gmail account, it is all I need to find movies, news etc.

    Long on NFLX, AAPL

    marco

  • Report this Comment On July 23, 2013, at 4:36 PM, Johny205 wrote:

    Amazons is a lot better. They have all the free crap shows you don't want to watch--just like Netflix except you can pay a few bucks and watch shows that are brand new, some of them are still in the movie theatres.

    Scrolling through Netflix is like: what should I watch? Junk, junk, or more junk.

  • Report this Comment On July 23, 2013, at 7:46 PM, BentMike wrote:

    Leaving out the international potential and saying it won't happen for 2 or 3 years vs. writing options to bail out at $275. There are to mutually unintelligible languages being spoken here. Both can even be correct assessments.

    And Johnny thinks everyone watches exactly the same thing he does and has the same taste in presentation. Not realistic.

  • Report this Comment On July 26, 2013, at 1:58 PM, ziq wrote:

    I panicked a couple of years ago and sold all of Netflix on rumors of internal discontent within the company (in the afternath of their unpopular decision to split online and DVD services). I took a decent profit but nothing like I would have gotten had I stayed. Based on the article, now might not be the best time to get back in.

    Adam's "subscriber" model may be OK for purposes of this comparison. But whereas a Netflix subscriber is always paying until terminating the service, an iPhone "subscriber" may decide after a couple of years not to afford the new phone right now, and in any case is paying a lot more to the service provider, which Apple doesn't see directly.

    I've noticed Netflix seems to underbuild their infrastructure. For example, when they premiered and were actively promoting "House of Cards" (of which I'm a big fan, along with the British original) the service was sometimes unusable (unacceptably long and frequent rebuffering pauses). Things seemed to get better with time. All that is anecdotal since network traffic conditions can vary widely regardless of what Netflix is doing.

  • Report this Comment On July 26, 2013, at 2:19 PM, SwiperFox wrote:

    The big difference is that Netflix shareholders have already had their "shock to the system." They look at the current price warily and are probably taking profits when possible.

    Apple shareholders are still in shock.

    I own both, but only see Apple as a buy at the moment. Even that's a bit speculative.

  • Report this Comment On July 26, 2013, at 2:35 PM, Truth2Power wrote:

    Johny,

    I agree with you halfway: Netflix needs to get better MOVIES. However, their TV offerings are top-notch and include House of Cards, Breaking Bad, Mad Men, Arrested Development, and many others. Their children's programming is also superlative. I've always found their movie offerings to be lacking, but hopefully their deal with Disney will help to mitigate this somewhat. The Avengers is now available, for example...

  • Report this Comment On July 26, 2013, at 5:09 PM, TOM48 wrote:

    Still have 600 shares of Netflix that I bought at 9.64. Sold 400 @ $300. Still have 270 shares of Apple that I bought 2 $95. Sold 130 shares at $667 & paid off my house. These 2 have been very good to me.

  • Report this Comment On July 27, 2013, at 10:29 AM, Caterbusa wrote:

    One difference I see is that when Apple was the darling of the stock market it had a PE of 20, not 300 like Netflix does at the moment.

    The minute Netflix growth stops, there will be a lot of people looking to sell their overinflated asset. The difference is aapl had 0 debt and 150B$ in cash. Netflix has 54% debt.

    I am definitely bearish about nflx.

    Your mileage may vary of course.

  • Report this Comment On July 28, 2013, at 9:09 AM, Stockhawker wrote:

    I cannot believe that not a single comment on Netflix has made any reference to their financial statements. These are not investors, you are all gamblers. Let me educate you all. If you bought the entire company of Netflix today, it would take you over 550 years to pay for the business out of current earnings. And just what exactly would you be buying over this 550 years? You would be buying a negative $700 million. That's right. All you fools who own shares in Netflix are paying to own a piece of a debt worth over $700 million, and a right to nothing in the way of income for yourself. The only thing driving this stock is the idiots that think that because Netflix is a good idea, it must also be a good investment. And to try to compare it to Apple? What a joke. Apple has a very strong balance sheet. Netflix? NOT!!!

  • Report this Comment On July 28, 2013, at 11:08 PM, 650nm wrote:

    I'm pretty sure that any comment on these boards calling anyone else a "joke" or an "idiot" can be safely stepped right over.

  • Report this Comment On July 29, 2013, at 7:49 PM, dsciola wrote:

    EBIT / Interest Expense (Interest Coverage Ratio) of 5.1x

    EBITDA / Interest Expense of 7.1x

    Debt / EBITDA of 2.9x

    current ratio of 1.5

    D/C of 33%

    D/E of 45%

    cash / debt of about 2x...using all cash & equivalents at 1080mm and total LT debt of 500mm...

    Not seeing the ticking debt time-bomb...and when was the last time a company's solvency was valued using earnings?

    Perhaps if the stockhawker provided some semi-intelligent analysis of NFLX's content costs, he'd have a point...Not sure the 'financials' and the debt story are tying out...unless I am looking at another NFLX...

    Dom

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