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Warning: Water is Deeper than it Appears

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By Joelshann
September 9, 2005

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Living in the Mississippi Delta you learn an important truth: water may be deeper than it appears. Because the entire landscape is flat, where there are gullies and ditches, there is no indicator that such pitfalls are there. You can easily be walking along in 2 inches of water and suddenly to find yourself 6 feet under.

That's the illustration that comes to mind when I think about Netflix (NFLX) (Let me say here, I own Netflix�a measly 83 shares�and I have no intention to sell.) Many are asking, "What's driving the price up?" There hasn't been any real bad news lately, and the good news is mediocre at best. So what is driving up the price? In order to answer that question, we first have to understand what caused the stock to drop so much in the last 20 months.

Going back to my question nearly a year ago, I believe the drop in price was precipitated as much by emotion and ignorance as by reality. Ignoring for the moment the emotion and ignorant aspects, let's look at reality. The funny thing about reality is that it's 'perspectival': where you're standing impacts what you can see. I've followed the debates regarding Blockbuster (BBI) and Netflix for the last year. I've listened to the nonsense from those looking to make a quick buck via a lawsuit. I've listened to the talking heads talk the stock down and call it a bad investment. But these people were looking at the surface of the "moat" that surrounds the business model that Netflix has established and perpetuates. The water didn't seem too deep, so anybody could take the hill, right? Wrong. Blockbuster is out. Amazon is in the hold position. Local versions have cropped up, but pose as much threat to Netflix as my front-yard vegetable sales do to the Super Wal-Mart down the street.

What's driving up the price? Comprehension, understanding, and a realistic appraisal of the depth of the moat that is Netflix. We also have to ask, did Netflix drop below $10 because that was its intrinsic value, or for some more subjective reason like emotion and the vague potential for competition? If you truly believe the former, then folks sell you shares and count yourself lucky. But if you, like me, believe that the intrinsic value was never $10 and the threat never so real, or deep, as it once seemed, then the shares have risen closer to what they are worth.

If you sold Netflix, stop reading here. Otherwise....

Much of this is to now Deltonian tea-and-crumpet chatter. The more pressing question to folks like me remains, what is Netflix worth? When is it priced for a sell? Well, consider the environmental conditions: First, the movie business�which is having problems selling DVDs�certainly isn't going to be moving away from them any time soon. Second, people haven't stopped watching movies. Third, and more immediately, Netflix "predicts fiscal 2006 pretax income of $50 million with a target profit-growth rate of 50 percent over the next several years" and "Netflix also set a goal of attracting 20 million subscribers in five to seven year" according to an AP report. In summary, a growing business with a wide moat, lots of room to grow, and increasing subscriber base. And that doesn't even take into consideration the potential that Netflix has use its market leadership to further carve a lasting niche out of the entertainment landscape of American culture. Who knows, besides enjoying the 'perspectival' view from the castle, Hastings might right now be dreaming of the others ways to paint the town red (even as I dreamed for Netflix almost a year ago.)

You want my advice. Let the bottom feeders short Netflix. I like the company of the boat I'm in, and not too concerned (for the immediate future) with what lives in the waters beneath. At the very least, out of consideration to shareholders of Blockbuster and others, we should post a sign declaring, "Warning: water is deeper than it appears."


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