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Netflix's CEO, Reed Hastings, has long been considered a pretty good CEO. In January, 2009 his Glassdoor approval ranking was an astounding 93%. In January, 2010 his 75% approval rating kept him on the top 25 list. It was not surprising, given that he had happy employees, happy customers, and with Netflix's successful trashing of Blockbuster the company's stock had risen dramatically, leading to very happy investors.
But that was before Mr. Hastings implemented a series of changes in July and September. First Netflix raised the price on DVD rentals, and on subscription packages combining DVD rentals and streaming download, by about $$6/month. Not a big increase in dollar terms, but it was a 60% jump, and it attracted a lot of media attention (New York Times article). Many customers were seriously upset, and in September Netflix informed investors it had lost about 4% of its streaming subscribers, and possibly as many as 5% of its DVD subscribers (Daily Mail).
No investor wants that kind of bad news from a growth company, and Netflix's equity value went into a nosedive. The decline was augmented when CEO Hastings announced Netflix was splitting into 2 companies. Netflix would focus on streaming video, and Quikster would focus on DVDs. Nobody understood the price changes - or why the company split - and investors quickly concluded Netflix was a company out of control - about to flame out.
This has to be about the worst company communication disaster by a market leader in a very, very long time. TVWeek.com said Netflix, and Reed Hastings, exhibited the most self-destructive behavior in 2011 - beyond even the Charlie Sheen fiasco! With everything going its way, why, oh why, did the company raise prices and split? Not even the vaunted New York Times could figure it out.
But perhaps there is a good explanation. And we can find it by taking a moment to compare Netflix with another company having recent valuation troubles - Kodak.
Kodak invented home photography, leading it to tremendous wealth as amature film sales soared for seveal decades. But last week Kodak announced it was about out of cash, and was reaching into its revolving credit line for $160million to pay bills. This latest financial machination reinforced to investors that film sales aren't what they used to be, and Kodak is in big trouble - possibly facing bankruptcy. Kodak's stock is down about 80% this year, from $6 to $1. And a disastrous fall from the near $80 price it had in the late 1990s.
(Source: Yahoo Finance 10-3-2011)
Why Kodak declined was well described in Forbes. Despite its cash flow and company strengths, Kodak never succeeded beyond its original camera film business. Heck, Kodak invented digital photography, but licensed the technology to others as it rabidly pursued defending film sales. Because Kodak couldn't adapt to the market shift, it now is probably going to fail.
And that gives us clues as to what Netflix is up to, and why investors should revisit Netflix. Netflix is taking strategic actions to shift with its market, and avoid a Kodak-like fate! Although things were poorly explained, and certainly customers were not handled well, last quarter's events are the right move for investors in the shifting at-home video entertainment business:
- DVD sales are going the direction of CD's and audio cassettes. Meaning down. It is important Netflix reap the maximum value out of its strong DVD position in order to fund growth in new markets. For the market leader to raise prices in low growth markets in order to maximize value is asmart strategic step. Netflix should be lauded for taking action to maximize value, rather than trying to defend and extend a business that will most likely disappear faster than any of us anticipate - especially as smart TVs come along.
- It is in Netflix's best interest to promote customer transition to streaming. Netflix is the current leader in streaming, and profits are better there. Raising DVD prices helps promote customer shifting to the new technology, and is good for Netflix (as long as customers don't change to a competitor.)
- Netflix needs to maximize its resources on streaming. Although Netflix is currently the streaming leader it has serious competition from Hulu, Amazon, Apple and others. It needs to rapidly build its customer base, before new users go to competitors, and doing that requires funding its streaming business in order to obtain more content. Not only to negotiate with more movie and TV suppliers, but to fund additional exclusive content like the new Lillyhammer series (more at GigaOm.com). Content is critical to maintaining leadership, and that requires both customers and cash.
- Netflix cannot afford to muddy up its streaming strategy by trying to defend, and protect, its DVD business. Splitting the two businesses allows leaders of each to undertake strategies to maximize sales and profits. Quikster will be able to fight Wal-Mart and Redbox as hard as possible, and Netflix can focus attention on growing streaming. Again, this is a great strategic move to make sure Netflix transitions from its old DVD business into streaming, and doesn't end up like an accelerated Kodak story.
Historically, companies that don't shift with markets end up in big trouble. AB Dick and Multigraphics owned small offset printing, but were crushed when Xerox brought out xerography. Then, afater inventing desktop publishing at its PARC facility, Xerox was crushed by the market shift from copiers to desktop printers; a shift Xerox created. Pan Am, now receiving attention due to the much hyped TV series launch, failed when it could not make the shift to deregulation. Digital Equipment could not make the shift to PCs. Kodak missed the shift from film to digital. Most failed companies are the result of management's inability to transition with a market shift. Trying to defend and extend the old marketplace is guaranteed to fail.
Today markets shift incredibly fast. The actions at Netflix were explained poorly, and perhaps taken so fast and early that leadership's intentions were hard for anyone to understand. The resulting market cap decline is an unmitigated disaster, and the CEO should be ashamed of his performance. Yet, the actions taken were necessary - and probably the smartest moves Netflix could take to position itself for long-term success.
Perhaps Netflix's value will fall further. Short-term price predictions are a suckers game. But for long-term investors, now that the value has cratered, give Netflix strong consideration. It is still the leader in DVD and streaming. It's revenues continue growing - they did not stall. It has an enormous customer base, and it looks like the exodus has stopped.
Netflix is now well organized to compete effectively, and seek maximum future growth and value. With a better PR firm, good advertising and ongoing content enhancements Netflix has the opportunity to pull out of this communication nightmare and produce stellar returns.
Links:
The original case for owning Netflix, which still holds up, from November, 2010
How Netflix brilliantly handled the evolution from physical to streaming while beating Blockbuster
How Netflix planned for the industry shift to streaming - GREAT CHART
Kodak was stuck in defend strategies in 2005 - and it was predicted then the company would fail
A lesson for managing market shifts - Why Kodak waited too late (like most companies)
How to recognize a company in the Whirlpool of decline - Kodak case study
