A short history & market analysis of Netflix

The story starts in 1997 when Reed Hastings started Netflix, because he was charged $40 in Blockbuster late fees from returning Apollo 13 late. That was the times when Blockbuster dominated the movie rental market in the US. In 2001, Blockbuster generated over $5.6 billion in revenue, with over $1 billion of that in late fees and customers didn’t exactly appreciate it. That resulted into an opportunity for innovators into the market. For $20 a month, Netflix let customers rent as many movies as they could mail back and forth in a month. This new strategy offered a superior customer value and got a slice of the Blockbuster customers, but struggled to be profitable. Today the DVD rental is less than 1% of Netflix business and is offered exclusive to US.

With the rise of the internet, the streaming alternative became a viable and smart approach. At the beginning of 2019, 139 million people around the world payed to stream Netflix TV shows and movies.  One of Netflix strength is it’s adaptability to various type of customers and to different streaming options devices. It released 88% more original programming in 2018 than it did the previous year. According to Forbes that cost Netflix $12 billion and the spending on original shows and movies is expected to hit $15 billion this year. It now invests more in content than any other American TV network. One big problem and one of the company weaknesses is that to fund its new shows, Netflix is borrowing huge sums of debt. It currently owes creditors $10.4 billion, which is 59% more than it owed this time last year and is estimated that amount will grow in the coming years to $32 billion. So, market growth needs to be on the top of the list. Growth comes from retaining the customers while attracting new ones but this will be a challenge in the future with the new players in the market. Amazon, Walt Disney, Apple and AT&T competing to get a share of the Netflix customers.

The company’s strategy is to focus on original content to drive growth like quality movies and TV shows and it is not currently looking to stream live events or sports. Netflix is aiming to build a portfolio of movies which will attract and retain viewers on-demand commercial free viewing. This should help Netflix to stand out from its competitors and attract more subscribers.

While Netflix’s domestic subscriber growth has been slowing down, during Q2 2019, it still represent a third of the business revenue. Netflix posted its first decline in U.S. paying subscribers (130k subscriber losses) in almost eight years, partly due to price hikes that the company recently carried out. The majority of Netflix’s growth over the last few quarters has come from international markets, which represent 67% of their business, most of Europe’s developed countries. Currently, the company is producing shows in 13 countries and streaming in more than 190 countries. At this moment just Amazon represent a real competitor on European market. Netflix strategy is to get a share from developing countries from Eastern Europe, Asia and Africa. This may prove harder in some situations like India, where the speed of the internet is lacking and the consumer prefers pirated streaming. But, at least for the moment, Netflix still represents the platform of choice for Americans, according to Statista:

Disney owns Marvel, Pixar Animations, Star Wars, ESPN, National Geographic, Modern Familyand The Simpsons. It delivers this content through cable providers. So, cord cutting has hit this business hard. Disney’s cable business has stagnated over the past seven years. In order to adapt is set to launch it’s own streaming service for $6.99/month—around $6 cheaper than Netflix. And it’s pulling all its content of Netflix. That could imply a better customer value for some. Adding at this that, in the near future, Apple will launch it’s on streaming service, even cheaper than Disney’s at 4.99 and AT&T will launch HBO Max, Netflix will have a challenging path ahead. Netflix still has an edge, for now, at least. Netflix achieved a score of 80.2 in rankings based on YouGov BrandIndex’s word of mouth metric, which measures whether a respondent has discussed a brand with friends or family (in person, online or via social media).

Below are the trends of the tech sector (NASDAQ in blue) that Netflix and it’s competitors are related to and of each one separately.

The trends are similar in the past but the velocity of the summer down move in NFLX disrupted this and if at some point this year it registered an up move of around 50% from the beginning of the year, few days ago it was barely negative. At the moment in a matter of 3 months it decreased 46%. AAPL & T weren’t that affected, while DIS and AMZN were just mildly affected. ROKU is another stock affected by all this and had a similar down move as NFLX. One reason for that is that the other companies don’t have the movie streaming as a primary source of revenue.

This down move in Netflix shows the fear of the investors for the upcoming future and automatically the rise in volatility before the earnings. While the earnings were better than expectation, were based on international subscribers. I find it strange the drop in volatility after earnings, double than usual.

Netflix Implied Volatility

With the Implied Volatility Rank at 8% and IV at 34% there are not that many options strategies to which we can relate to. But the correlation with Nasdaq at the beginning of the year was around 80%. Last week, before earnings, it dipped below 50%. So, it can be used as an opportunity for portfolio diversification. There’s still some juice left in the price of the options and a neutral strategy like Iron Condor could be a choice. Another alternative, if you are over-exuberant over the future is to go long…

I will stay on the sidelines for now.

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