I typically do not try to over-interpret the business practices of my investments. As the co-owner of the company (i.e. a stockholder), I have hired a qualified board to oversee my interests and make sure the day to day managers of the company are executing well. However, every once in a while I have to question the management decisions of one of my investments. In this case, it is Netflix (NFLX) [stckqut]nflx[/stckqut].
Netflix just announced a fairly major rate hike on its various subscription packages. In some cases, that rate hike was as much as 60%. While this may bump up the short-term revenues for the company, it is also possible that some people will choose a cheaper package or choose a new source for video entertainment. That would result in Netflix dropping revenue.
Some investment advisers speak of a “moat” around your company – I don’t believe that such a moat exists for most companies. Netflix grew by jumping the “moat” of the traditional video stores like Blockbuster back when that moat was the presence of a great network of brightly lit stores with a lot of stock. Now those stores are empty or turned into Chinese restaurants or clothing resell stores. Most “moats” in the 21st century are more analogous to drainage ditches that are easily crossed by a determined competitor. Therefore, as an investor, we must be ready to always escape out the back of the castle of our investment if the moat looks like it is going to be breached.
It is important for investors to not get too jumpy though. Remember, we hire good managers at the companies that we have invested in too carefully make these decisions. There may be very solid reasons for Netflix to change its pricing and force people into new subscription packages or pay more for their existing package. The Netflix contract with Starz for much of their streaming revenue is about a year from renewal and this may be a way to control some of those costs. They just did a streaming deal with NBCUniversal and perhaps that content justified an enhanced subscription model at this time. It also may be a way to control the costs of DVD distribution. If we trust our managers, then our concerns about their pricing model (or anything else in the daily running of the business) should be qualified. The reality is that we don’t work there and we don’t think about these issues all day long.
It is relevant though to be a little concern when there are various pages on Facebook now protesting the change. The good news for Netflix, at the time of this writing none of these pages have gone especially viral and are still under about 10,000 likes for each page that I found. Even the “1,000,000 people who will not stand for Netflix’s new prices” page is currently at an extremely small percentage of that goal. However, the power of the social network is always a concern and if these pages catch on there could be some affect on revenues.
The other good news is that Piper Jaffray just raised its target for NFLX to $330 (about 10% above current price which closed yesterday just shy of $299). When I last reviewed the stock back in April I said that it was probably a good buy until $297. I am not ready to re-review NFLX but if I did, my back of the envelope calculation puts me above PJC’s target. There is some confidence that comes from a company that is up about 20% from 3 months ago, about 35% from 6 months ago, and approximately 60% from a year ago.
So is NFLX at risk? Maybe, but don’t panic yet. The technicals on the company are still very good. They have really good managers that have put the stock where it is today, we should probably trust them that they know what they are doing. However, the next quarterly report and annual report from the company will give us a good clue if the new pricing is hurting their subscription rate. Also, the popularity of the pages on Facebook will be an early indicator of risk. There are companies that are trying to attack Netflix (e.g. Apple and Amazon) but maybe the walls of the Netflix castle are strong even if the moat is not that deep.