Part of gaining experience as an investor is understanding the lifecycle that most companies face. Many investors start out by becoming familiar with a company at the peak of its success, having generated strong growth and seeming to be on a path that will lead to even greater heights for revenue and profits. Sometimes, that growth can continue for a long time. Eventually, though, most companies reach a point at which what has worked in the past no longer works quite as well, forcing them to switch gears and try something new. When that happens, it can cause a big shift in sentiment and create a challenge for longtime shareholders to figure out what to do next.
In creating the Voyager Portfolio, one of my goals was to cover companies that don't get very much attention. In that light, it might make very little sense to look at streaming video giant Netflix (NFLX 0.73%), which has one of the best track records in the Motley Fool universe as a longtime recommendation. However, Netflix makes a great example of a company has dealt with growing pains in the past and now finds itself in a similar predicament today. With that in mind, this three-part series on Netflix will examine the growth stock's history, its financials, and its future prospects.
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Once a disruptor...
Netflix got going in the late 1990s, and its business originally looked nothing like what the company does today. Using a decidedly low-tech business strategy, the company co-founded by Reed Hastings had a very simple idea: rather than forcing consumers who wanted to rent movies and videos to leave their homes and visit a retail location -- most commonly run by industry leader Blockbuster Video -- Netflix would mail DVDs directly to viewers.
That system worked well, and Netflix tapped into the then-fledgling internet to add to users' convenience. One big breakthrough happened not long after the company's founding. Rather than charging for each rental like Blockbuster did, Netflix offered subscription services that allowed members to have a certain number of DVDs out at any given time. Once you returned one DVD, you could set up a queue that would automatically send the next DVD on your list to you. This system removed one of the biggest hassles of video-store rentals, the late fee, because subscriptions didn't hinge on how many movies you watched. Netflix was happy to let you hang onto a DVD for the whole month as long as you paid the subscription fee.
... always a disruptor
Netflix's business boomed, but what really set the company apart was its recognition that its original business model wouldn't thrive forever. When the DVD-by-mail pioneer introduced video streaming in 2007, it seemed to some like it was cannibalizing its own business. But having been primarily responsible for the death of Blockbuster, Netflix knew all too well that it couldn't afford to keep pursuing a way of doing business that would quickly become obsolete.
Streaming removed Netflix's reliance on the U.S. mail, and it opened up international markets where efficient, low-cost delivery simply wasn't available. But Netflix then realized that having tens of millions of content-hungry subscribers required that it have premium offerings available to show to them all the time. That made Netflix potentially vulnerable to supply chain pressures from entertainment companies, and so to build leverage, Netflix started taking responsibility for generating its own content. Award-winning series helped bolster the company's reputation even further and made subscribing to its service a must among fans of new and highly entertaining content.
NASDAQ: NFLX
Key Data Points
Showing shareholders the money
The business story of Netflix is fascinating. The financial story, though, is even more so, and it shows how longtime Netflix shareholders were able to make so much money. Moreover, in the context of the stock's most recent decline, it sheds some light on whether Netflix is turning into a value stock. Tune in for the next installment tomorrow.
