NETFLIX: a COMPANY ANALYSIS Prepared by Group 5: Alex Krengel, Annie Dudek, Rick Momboisse, Trish Paik, & Tyler Martin Table of Contents
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2010 Santa Clara University MGMT 162- Capstone Professor Schneider Winter Quarter:2010 NETFLIX: A COMPANY ANALYSIS Prepared By Group 5: Alex Krengel, Annie Dudek, Rick Momboisse, Trish Paik, & Tyler Martin Table of Contents I. Wall Street Journal Article and Executive Summary ..4 I A. Wall Street Journal Article 4 I B. Executive Summary ..5 II. External Analysis ..7 II A. Industry Definition ..7 II B. Six Industry Force Analysis ..8 II C. Macro Environmental Forces Analysis, Economic Trends, and Ethical Concerns ..15 II D. Competitor Analysis ..17 II D. 1 Netflix’s Competitors ..17 II D. 2 Netflix’s Primary Competitors ..17 II D. 3 Primary Competitors’ Business Level and Corporate Level Strategy ..18 II D. 4 How Competitors Achieve Their Strategic Position ..18 II D. 5 Willingness to Pay ..21 II D. 6 Comparative Financial Analysis ..22 II D. 7 Implications of Competitor Analysis ..23 II E. Intra-Industry Analysis ..24 III. Internal Analysis ..24 III A. Business Definition/Mission ..24 III B. Management Style ..24 III C. Organizational Structure, Controls and Values ..25 III C. 1 Organizational Structure ..25 III C. 2 Organizational Controls ..25 III C. 3 Organizational Values ..25 III D. Strategic Position Definition ..26 III D. 1 Corporate Level ..26 III D. 2 Business Level ..27 III D. 3 Resource & Capability Level ..28 Value Minus Cost Profile ..28 Value Chain ..28 VRIO Analysis ..28 Consumer Retention Analysis ..29 4Ps Analysis ..29 Product Life Cycle ..30 III E. Financial Analysis ..31 III E. 1 Netflix Financial Performance Analysis ..31 III E. 2 Valuation of Netflix ..32 III E. 3 Scenario Analysis ..33 IV. Analysis of the Effectiveness of the Strategy ..34 V. Recommendations ..35 V A. Short-Term and Long-Term Recommendations ..35 V A. 1 Short-Term Recommendations ..35 V A. 2 Long-Term Recommendations ..36 V B. Strategy Implementation ..38 V B. 1 Short-Term Strategy Implementation: Video Game Industry ..38 V B. 2 Long-Term Strategy Implementation: Streaming ..38 V C. Corporate Social Responsibility and Ethical Decision-Making Practices ..39 VI. Conclusions ..39 VII. Bibliography ..40 2 | P a g e VIII. Main Appendix ..43 Exhibit 1: Video Entertainment Industry Diagram ..43 Exhibit 2: Average Weekly Hours of Consumption by Age ..43 Exhibit 3: Average Weekly Hours of Consumption by Age Chart ..44 Exhibit 4: Leisure Activities at Home, by Age ..45 Exhibit 5: Hours Available for Leisure per Week ..46 Exhibit 6: Industry Six Forces Analysis ..47 Complements .. 47 Threat of Entry ..48 Supplier Power ..50 Buyer Power ..53 Rivalry ..55 Substitutes ..56 Exhibit 7: Market Share (Retail and Rental) ..57 Exhibit 8: Market Share (Rental) ..57 Exhibit 9: Average Annual Sales Growth ..58 Exhibit 10: Average Gross Profit Margin ..58 Exhibit 11: Average Return on Assets ..59 Exhibit 12: Average Debt-to-Equity ..60 Exhibit 13: Current Ratio ..60 Exhibit 14: Average Collection Period ..61 Exhibit 15: Average Asset Turnover ..61 Exhibit 16: Average Inventory Holding Period ..62 Exhibit 17: Industry Financial Ratios ..63 Exhibit 18: Netflix, Inc. Organizational Chart ..69 Exhibit 19: BCG Matrix ..69 Exhibit 20: VRIO Framework ..70 Exhibit 21: Value Chain ..71 Exhibit 22: Netflix, Inc. 2008 Income Statement ..71 Exhibit 23: Cost of Debt/Cost of Equity ..72 Exhibit 24: WACC Weights ..73 Exhibit 25: Netflix, Inc. Income Statement Plus Warner Bros. Agreement Changes ..74 Exhibit 26: Cost of Debt/Cost of Equity ..75 Exhibit 27: WACC Weights ..76 Exhibit 28: WACC Calculation ..78 Exhibit 29: Capital Expenditure ..79 Exhibit 30: Net Working Capital ..79 IX. Financial Background Appendix ..79 IX A. Netflix Current Value 2008 ..79 IX A. 1 Justification of Approaches ..79 IX A. 2 FCF Analysis ..80 IX A. 3 Growth Metrics ..82 IX A. 4 Free Cash Flows ..83 IX B. Netflix Valuation Incorporating the Warner Bros. Deal ..84 IX B. 1 FCF Analysis ..84 IX B. 2 Growth Metrics ..86 IX B. 3 Free Cash Flows ..88 3 | P a g e I. Wall Street Journal & Executive Summary I A. Wall Street Journal Article UPDATE: Netflix, Warner Bros. Reach New Deal By David B. Wilkerson January 6, 2010 Online DVD rental pioneer Netflix Inc. (NFLX) has reached a new deal with Warner Bros. Home Entertainment that will make new Warner Bros. DVD and Blu-ray titles available for rental 28 days after their release, the companies said Wednesday. The new agreement addresses the shifting preferences of consumers who appear more reluctant to buy DVDs in a shaky U.S. economy and a wider array of entertainment options. Terms of the latest deal also cover Warner Bros. titles made available for streaming to Netflix customers. Streaming is an increasingly important part of the company's strategy in the digital age; the number of subscribers who streamed a movie or television episode from Netflix jumped by 20% over the third quarter of last year. Warner Bros. Home Entertainment, owned by Time Warner Inc. (TWX), announced its intention several months ago to renegotiate terms with Netflix. Time Warner Chief Executive Jeff Bewkes told investors in September that the previous deal's economics didn't "make sense" for the studio. Most DVD sales come in the first weeks of a title's release. In October, Netflix CEO Reed Hastings said his company would not be opposed to a "sales-only" window of about a month at any studio, as long as Netflix could reach favorable terms. "We've been discussing new approaches with Warner Bros. for some time now and believe we've come up with a creative solution that is a 'win-win' all around," said Ted Sarandos, chief content officer for Netflix, in a statement. Ron Sanders, president of Warner Bros. Home Entertainment, said "The 28-day window allows us to continue making our most popular films available to Netflix subscribers while supporting our sell-through product." The weakened economy and the advent of $1 rentals, most notably from kiosks operated by Coinstar Inc.'s (CSTR) Redbox, have contributed to this trend towards fewer sales and more rentals. But because the majority of Netflix's shipments to customers are catalog titles, it is less dependent on new releases than its DVD-based competitors. For that reason, the company is perhaps better positioned to adapt to a delayed-rental strategy faster than its rivals - most pointedly, Redbox. Still, Netflix said Wednesday that its new agreement with Warner Bros. gives it better access to new releases, which currently account for about 30% of its total shipments. 4 | P a g e Netflix shares were up 3.2%, at $53.15 in late-afternoon trading Wednesday. Time Warner stock was down marginally, at $29.04. I B. Executive Summary Netflix Inc. is in the home video entertainment market, within the larger video entertainment industry. Horizontal markets include Airline, Hotel and Theater video entertainment markets. All four markets together make up the industry. Video rental and retail combined made Netflix’s market worth $26.7 billion in 2008. (BBI) The market is segmented into a number of strategic groups, which include brick and mortar rental and sales, DVD vending kiosks, online rentals and sales, mail-delivery services, and video-on-demand services accessible through the television. Due to rapid technology convergence, which characterizes the quality of the disruptive technologies, the rental portion of the market is changing from physical rentals to digital rentals, provided via streaming channels through broadband-connected set-top boxes, game consoles, and computers. All work to bring streaming content straight to the consumer’s television, making viewing interactive, easier, and available whenever the consumer wants it. Consumers may be broken into two segments, needy consumers and convenience consumers. Needy consumers are typically older, and less prone to using new technologies and are committed to watching specific programming, while convenience consumers are younger, watching video when they can, often utilizing technologies to access titles on their schedule. Netflix’s primary competitors are Blockbuster and Comcast. Blockbuster has the majority of the market share (52 percent), Netflix has 13 percent, and Comcast has 3 percent. Netflix adds most value to consumers through low capital and input costs, and through convenience of streaming video. For our comparative financial analysis, we took five years of data (from 2004 to 2008) and compared competitors based on growth, profitability, leverage, liquidity, and efficiency. Netflix saw the most growth on average (40.3 percent/year), whereas Blockbuster saw negative average growth (- 2.16 percent/year). Blockbuster, Netflix, and Comcast all saw good positive profit margins, but in terms of efficiency Blockbuster and Comcast had return on assets below the industry average. Netflix is the most efficient out of these three companies, with an ROA of 10.39 percent. Netflix also does not leverage its business with debt, whereas Blockbuster does. Blockbuster has an average debt-to-equity of 4.42, suggesting that it has a high credit default risk if it continues to see negative growth. Our competitor analysis showed that the traditional Home Video Entertainment industry is reaching stasis. Netflix should continue its reach into streaming video, as consumer demand is moving towards streaming. Netflix Inc. and Warner Bros. reached an agreement in January of 2010 regarding movie title acquisitions. Within the agreement, Netflix Inc. (NFLX) has agreed to accept new titles 28 days after being released to the public. In return, Warner Bros. have agreed to provide Netflix with more titles released later than five years ago and “straight-to-video” DVD, Blu-ray discs, and streaming video that are currently not offered. Warner Bros. has agreed to continue ongoing negotiations regarding price changes that will favor Netflix’s title acquisition prices. 5 | P a g e The recent agreement between Netflix and Warner Bros.