Tuesday, April 24, 2012


What bothers me about investing these days is the disconnect between a company's inherent worth--its capacity to address market needs and customer desires, translating those solutions into real profits for the company while delivering benefits for its customers--and the value of its shares.

NFLX, source E*Trade Financial

Let's take Netflix for example. Netflix was founded in 1997, as an online version of a traditional DVD rental and sales outlet.* In 1999 they lighted upon a brilliant scheme: offer DVDs through the mail by subscription for a flat monthly fee. By early 2000, they dropped the per item model entirely. Brilliant!

In 2002, the company went public. Already in 2000, CEO and founder Reed Hastings saw the future of Netflix as "owning a transition stage as rental converts to video-on-demand." Clearly, ahead of his time, the streaming model was in mind. To put that in perspective, YouTube was not founded until 2005.

Towards the end of the first decade of the 21st Century, Netflix was on a tear to increase its share of streaming as a percentage of its business. By 2011, the decision was made to make the shift. Sure, there were some missteps in designing and executing the shift, and in anticipating and responding to customer confusion and resistance to the shift.

But here's my take: the model is sound. The DVD through mail model was innovative in terms of distribution and convenience. The streaming model is liminal (in part because the infrastructure to handle the huge amounts of bandwidth required is still fragile as ISPs seek a profitable path forward) but clearly the future. A future that Netflix foresaw.

But the share price of Netflix stock is volatile beyond reason. In the middle of 2011, around the time of upheavals regarding separation of DVDs from streaming, the share peaked at around $300, dropping below $70 before the end of the year. Then back up, and now, today, shares fell off a cliff, off by 10-15% from yesterday!

NFLX falls off a cliff 4/24/2012, source E*Trade Financial
Sure, even at today's pricing, Netflix trades at a PE ratio north of 30. And the news that came out yesterday is that Netflix exceeded analysts estimates. While revenues grew by 21 percent, it lost 8 cents per share as opposed to the 27 cents per share analysts expected. The point I make is that stock prices, and the wild swings of over-selling and over-buying, are out of line with a company's core, which is delivering market solutions, and making a profit on sales that exceed costs.

A business leader should remain focused on this: how do I develop and deliver products and services to the market that benefit my customers and make a profit for my company, employees, and owners? But the stock market distorts these values. It certainly gives this entrepreneur pause in considering whether going public is an exit strategy to aspire towards.

Full disclosure: I currently own no shares in Netflix (NFLX). At the end of 2011 I made two purchases of shares at $67.25 & $67.89 respectively. All these shares were sold in February 2012 at $129.75. I am a customer of Netflix, formerly subscribing to the DVD mailing subscription, then DVD and streaming, currently streaming only.

* Much of the history of Netflix is gleaned from http://www.fundinguniverse.com/company-histories/Netflix-Inc-company-History.html & http://en.wikipedia.org/wiki/Netflix.

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