Last week, I called digital media expert Dan Rayburn out for missing the boat on how Netflix (Nasdaq: NFLX) will fare in the ongoing digital media revolution. Dan sees Netflix stock as way overvalued because its digital media streams are nowhere near replacing DVD discs or cable TV packages. I see a fixed cost structure supporting a rapidly rising number of customers, which will lead to outsized profits in due time, and if anything, Netflix is still too cheap.
Dan still doesn't think I make sense, taking the time to respond in person right here on The Fool:
The bottom line is that the consumption of digital media is growing, it's affecting multiple media industries, and it's very exciting. But one service is not replacing another anytime soon. Even with the positive balance sheets that Apple, Akamai, and Netflix have, one can't let the excitement around streaming movies and TV shows be the major catalyst for valuing them more highly.
In Dan's view, Netflix has proven that it can't replace cable by offering a streaming video model for three years without killing anybody. "75% of all U.S. consumers did not stream or download any multimedia content of any kind," he points out. Moreover, comparing streaming versus DVD to the DVD-versus-VHS battle is unfair because this time, we're asking consumers to shift between two fundamentally different delivery models while the last format war was fought over rival physical media.
You don't bet against a winning horse
OK. Netflix itself provides some key evidence of the rapid changes that are going on. As its customers either sign up just for the streaming services, or else shift down to a cheaper delivery plan that still gives them full streaming privileges, the average monthly revenue per customer slipped from $13.29 to $12.29 over the past four quarters. Moreover, you might think that lower average plan prices would hurt Netflix, but its customers are also requesting fewer mailed DVDs and thus widening the company's profit margins. I'd be worried if video streams didn't play a part in this movement, but I don't see how that can be the case.
In short, Netflix is not just a frontrunner in the digital entertainment race – it is the horse to beat. Apple (Nasdaq: AAPL) would be plain stupid to release its Apple TV box without Netflix support and even touts Netflix streams as a key feature of the iPad. The same goes for Google (Nasdaq: GOOG) and its Google TV, where Netflix support features prominently in the user interface. That's just a couple of the many delivery channels available to a Netflix subscriber today, showing broad industry support for the platform.
And Akamai Technologies (Nasdaq: AKAM), itself a leader in the field of highly efficient content delivery, couldn't be happier than landing Netflix as a customer to keep its network pipes full of flowing video bits.
Anecdotal evidence and hard numbers
I'm in the process of dumping my expensive full-featured cable package for a bare-bones alternative and supplement it with the one-disk Netflix plan myself. That setup will cover more than 90% of my family's media needs in a very affordable one-two punch, and I know I'm not the only one to consider a move like this. It may take many years to kill Comcast (Nasdaq: CMCSA) or Time Warner Cable (NYSE: TWC) this way, mainly because the cable guys have the advantage of owning live sports and local news broadcasts.
But the Time Warner family will surely feel the burn when Netflix streams start cutting into the conglomerate's crucial HBO division's sales and subscriber counts. An independent study by Credit Suisse indicates that as many as one-third of Netflix subscribers in the prized demographic between 25 and 34 are already turning to Netflix rather than pay TV channels like HBO or Cinemax.
Final words
The growth is there, the shifting customer loyalties are there, and we're only three years into this seismic shift. You might be able to convince me that Amazon.com (Nasdaq: AMZN) is overvalued relative to its importance in the fully digital media landscape, and Blockbuster is clearly overvalued at any price today. But Dan, I'll have to continue to disagree with your conclusion that the Netflix growth story doesn't match up to the stock's valuation.
