TMF: Reed, looking back over the past year and studying Netflix, the performance has been extraordinary. The stock is up multiple times in value and yet there was a lot of skepticism about the business and certainly that skepticism increased when Wal-Mart
Hastings: I think if you look at the Internet space generally, consumer Internet, people may have made money or lost money on different stocks but it wasn't because of competition. Yahoo!'s
So, competition really has not been a critical driver of shareholder value in the Internet space. Once someone gets a space, they tend to own it and it tends to be driven by business model and market size issues. I think any investor, large or small, could look at that and then substantially discount how effective Wal-Mart and Blockbuster
TMF: Let's leave competition aside. What sort of variables would you have a small investor look at to evaluate Netflix's performance a year ago or going forward today? Top-line growth? Free cash flow? Total number of new customers? Churn rate?
Hastings: Sure. A year ago I would have looked at free cash flow, which had been positive at that point for three quarters, so that gives you a safety net that there is not going to be a liquidity crisis, that things are steadily growing and that protects the downside a lot. Then I would look at the San Francisco Bay area adoption, which we have released over time and shown that it has grown to about 5% household penetration, because we have had overnight delivery in the San Francisco area for four years.
Then, of course, two years ago we rolled out overnight delivery to much more of the country and all of those areas are following the Bay area penetration curve exactly. They are continuing to grow. So we joke internally when we look at these graphs of household penetration steadily up and to the right that, to get to $1 billion in revenue, we just have to get these colored lines to follow that colored line, representing the San Francisco Bay area.
TMF: Reed, stepping away from things, Tom and I are certainly familiar with Netflix. I myself am a customer and somebody who has recommended your stock and happy to have done so because it has done so well. I put myself in the position of somebody just hearing this interview for the first time and learning about this business, and I think the big question on that person's mind is, "OK, I get you. DVDs are hot. They are taking over VHS tapes. In the next few years, it is a huge business."
But I think that person might wonder where will Netflix go when DVDs do get outmoded, presumably one day, by video on demand? Where is the business then and why would I buy the stock now?
Hastings: Sure, I think that is a great question. First, DVD is, of course, only 50% penetrated and has many years left before it peaks. Second, Internet consumer and Internet commerce comfort are steadily growing. So, we are riding two very big trends that are sort of 10- and 20-year trend stories positively over the next couple of years.
Also, the DVD is a huge part of the studio's revenues. Sixty percent now, and could be growing to 70% or 80% of studio revenues over the next five to 10 years. So that adds a lot of stability. There will be no quick changes in that because the studios will protect the DVD market in a very significant way.
Third, we are very well set up as an Internet business to essentially go from paper tickets to e-tickets or in this case from DVDs to downloads. That is actually a very simple transition for us. Instead of paying the post office to deliver the DVD, we pay one of the telcos and cable companies to deliver the Internet bits to our customers.
So, it is several years away. The studios have a huge desire to keep the market strong for DVDs because it is such a big part of their revenue. We are very focused on following that evolution. It is why we named the company Netflix. Ten, 20 years from now we want to emerge as one of the world's leading media companies using Internet movies as the core driver.
TMF: Are there any small, emerging companies that you encounter, either as competitors or partners or just in your observation of business, that impress you?
Hastings: There is a real small one, Audible.com, which I am now using on my iPod, which delivers spoken word -- audio books. It is great for anyone who has got a long commute and it's good to be able to download those onto my iPod.
TMF: Reed, what is your plan as CEO of the company? Do you expect to be heading up Netflix for the next 15 years? Do you look that far forward? What do you think your professional career will hold for you over the next 10 years?
Hastings: I certainly intend to do it for the long term. I ran a public company, a software company, Pure Atria Software, in the early '90s. That got acquired in 1997 and it took until now to get back to running another public company and I would like to do it for a very long time.
TMF: Let's close with our game, "Buy, Sell, or Hold." You have played it before. We will be throwing out things happening in business, or culture and asking you, Reed, if these were stocks would you be buying, selling, or holding right now and a sentence about why. Are you ready?
Hastings: Yeah, I am ready.
TMF: Let's start it off with, well, it is a hot product today, but still pretty pricey. If they were a stock, buy, sell, or hold plasma TV?
Hastings: LCD TVs are more stable and growing faster. They are going to replace plasma.
TMF: Your motley resume includes being president of the California Board of Education. So, Reed Hastings, buy, sell, or hold the likelihood that Gov.-elect Schwarzenegger can balance the California budget without raising taxes?
Hastings: Hold. I think he has got a credible chance to look at the audit, to look at the process fresh and find a lot of savings.
TMF: It was a much-maligned movie to say the least. Buy, sell, or hold renting the DVD of that Ben Affleck-Jennifer Lopez movie last summer?
Hastings: That would have to be a sell. We showed it at Netflix as an employee gag and no one showed up. (Laughter.)
TMF: Reed Hastings is the CEO of Netflix. Reed, thanks for joining us again on The Motley Fool Radio Show.