The Online Video Industry Is Flying High Right Now, But It Can't Last

Today, just about any company involved or associated with streaming movies or TV shows over the Internet seems to have evaluations that we haven't seen in quite a few years. Companies like Netflix, Apple, Akamai and others have share prices that seem to be based more on excitement, rather than basic business fundamentals. While there is nothing wrong with being excited about what's taking place in the market and the growth we are seeing in digital content consumption, many have now set expectations for these companies that simply can't be achieved.

I do a lot of calls with institutional money managers on the buy and sell side and lately, far too many of them are getting all caught up with the idea that online video is going to somehow replace cable, DVDs, or other forms of media. The fact is that today, digital content offerings from the likes of Hulu, Netflix, Apple and Amazon are a compliment to traditional media. There is no doubt that digital is growing, but online video is not replacing cable and streaming movies are not replacing DVDs today, or any time soon. Seismic shifts like that don't happen overnight or over a few years but rather usually over a long period of time, measured by a decade or more. To put it in perspective, Netflix has only been streaming for three years and while they have been the hands down leader, DVDs and cable TV are still around in volume.

When you look at the kind of money Netflix is spending to license content for digital, there is no way to run the numbers to show that Netflix can possibly sign up enough new subscribers over the next five years to cover their $1B licensing deal with EPIX. Yet in the past six months Netflix's stock has gone from $74 to $165 a share simply due to excitement. Financial analysts seem to be asking more about the rate of growth rather than how these services work, what the quality looks like, what devices they work on and what the business model looks like. I am amazed at how many financial analyst pieces I read where the author talks about a particular streaming service yet admits they have never used it. How can they possibly have tens of millions of dollars tied up in a company yet haven't spent $99 to buy a box and actually use the service for themselves?

I see a lot of investors making decisions based on three to five year projections of the size or growth of the industry while ignoring the reality in today's market. I keep hearing about devices, yet 95% of the time when I ask someone on Wall Street how many Roku's, TiVo's or broadband enabled TVs have been sold, they have no clue. How is that possible? How can you track or invest companies in this space who's sole growth is dependent on these devices yet not know how many have been sold, how they work or what the service looks like?

The last thing we need is another bubble, yet I'm afraid that what we currently have. I keep hearing or reading things that imply that the ad dollars from TV are flowing to online. Online video advertising is absolutely growing, but lets keep things in perspective. Last yet the online video advertising market was around $500M, the broadcast TV ad market was $60B. One is not putting the other out of business. And while digital video consumption is growing, it's not growing as fast as some may think. NPD just released numbers stating that 75% of all U.S. consumers did not stream or download any multimedia content of any kind in the past three months. That's the kind of data we need more of in the market to keep things in perspective.

Now I'm sure some are going to comment that I'm always negative or I always have to try and ruin someone's high but the fact is that setting the proper expectations is crucial in the long term success and growth of any industry which is all I care about. I'm not in this for the short-term and I don't play stocks. I've been in this industry for fifteen years and I want to be in it for another fifteen more. But in order for that to happen, the market needs to evolve into services that can become profitable and sustainable on real profits, not hype or future projections. Just take a look at how many companies in this space are actually profitable today. Very, very few. To help them get there we need sensible, rational thinking with expectations they can meet. Not evaluations based on wild projections and statements about one service killing off and replacing another.

I hate to say it, but the current bubble we are in is not going to be able to last much longer. Some of these companies are going to have to get knocked down and many on Wall Street are going to have to come back to reality. We need more folks looking at the core fundamentals of what companies have to offer as opposed to that day trader mentality which is simply trying to figure out if a stock will go up or down the next day.

Disclaimer: I have never bought, sold or traded a single share of stock in any public company ever.

Comments

[Alex Limbrios]

dan, you hit the nail on the head with this one. could not agree more.

[explorer18]

Bubbles are by definition irrational - and you are right - they won't last long - they occur when there is a critical mass of pundits that are excited about the next big thing.. and it is not strange that hardly anyone really understands it or cares to understand it. If it serves a purpose of making a quick buck, well it's worth pumping it up. So, Dan, I don't see how many of them will care to pay attention to the humble truth you speak.

On the other hand - the fact that there is such excitement in online video must cheer anyone who is in this industry as long as you are - especially as it also indicates a growth in the market and undeniable shift in public perception as well as market. For example, the bankruptcy filing of Blockbuster is a big reality check for this new trend.

So, while you are right, it is also time to see the emerging landscape. and get back to work.

[Dwayne]

Hi Dan - I'm Guilty. I'm also excited about the new developments in Internet streaming video. But, I more excited about the advancements from the consumer and hobbyist perspective. I'm a Netflix member and plan to buy Roku when it becomes available just to experiment for my blog.

The fact is, while you are right about the excitement level, I can't help but feel we're seeing a game changer as far as Internet Streaming goes. See: Social Media, any product released by Apple recently, Twitter, just to name a few. Most will get on the wave faster than we did with mobile phones and smart devices. In 1994, there were over 61 million pagers in use and pagers became popular for personal use, dare I say, sending "tweets" ;) Now people use Twitter and Facebook to communicate on a larger scale.

I understand the bubble perspective Dan, but I think we're at the tip of the iceberg as far as what Internet Streaming has to offer. Either way, it'll be a fun ride.

[Rob]

While I completely agree that we are in a bubble it also feels like we're turning a corner. People are cutting their cable, people under 30 aren't even getting cable (or a land line), the devices seem to be on the cusp of broader adoption, it is easier to configure them, and Blockbuster has finally failed (although you could argue that was because of huge debt and dumb management decisions moreso then lack of demand).

But- we are still a few years out. In the meantime I'm doubling down on Coinstar (Redbox). Why? Simple- no matter what happens you still need food and they have situated their kiosks in grocery stores.

[Paul Sweeting]

Hi Dan -- I completely agree on the irrational exuberance, but one quibble with your evidence. I really doubt Netflix put itself on the hook straight up for $1 billion in the EPIX deal. Like most such licensing deals, I'm sure there are escalators built in, probably tied to Netflix's subscriber count (just as its current Starz/Disney deal does). The $1 billion figure, if even true, no doubt reflects Netflix's total potential liability over the life of the deal, assuming all benchmarks are met and all escalators kick in.

[Dan Rayburn]

Hi Paul, no question that Netflix did not pay $1B upfront, but that $200M a year is with just ONE content partner. How many of those sized deals can Netflix afford to cut each year? Not that many. Based on the EPIX deal, the content costs we are starting to see in the market are big dollars. Going to require a lot of cash if Netflix wants to license newer content.

[Rick Wingender]

Hi Dan - thoroughly enjoyed your post. I think you're partially right and partially wrong.

I think you're wrong: online video WILL replace DVDs, just like 8-track, records, cassettes...all in the Smithsonian now. As a college student in 1991 and a part-time Best Buy commissioned computer and video salesman, I predicted to my scoffing co-workers that one day, all entertainment sources would come into the home through modems or whatever the next technology would be, and that people would be watching on their computers more than their TVs, and that this would happen within ten years. OK, I was wrong on the timing. But, I was talking about convergence, long before most people did. So now I'll temper my opinions on timelines, but I am convinced that DVDs will only be found in Appalachian Walmarts and Bangladesh within 10 years. This demise will be hastened by the closing of Blockbuster and Hollywood Video stores, which will drive consumers to Netflix. That in turn will have a cascading effect on the growth of devices to watch Netflix Instant Queue movies, which will in turn generate more interest in other sources of digital content. I believe that whether buying or renting, most people would rather deal with a TV menu than deal with a little round plastic disc that they have to return or buy. One more recent event will hasten the acceleration of device adoption: Amazon recently put its whole catalog of product on the Roku, not just digital downloads. That's instant credibility, and now other large companies will be begging Roku to let them have a channel. If they were public, I'd bet big on Roku.

I think you're right to be cautious, if we learned anything from the first internet bubble. You are again right in not understanding how anyone can make bets on something they haven't shelled out the $99 for to try. I own two Roku's at home, and I'm the #1 evangelist for Roku now (unpaid!). I'm even trying to convince my company to adapt our content for a channel. But like Peter Lynch said, the best investment research you can do is to experience the product. You're also right about video advertising. I'm in E-commerce, and online search and other marketing tools are sexy and measurable, but most of my compadres don't seem to understand that we're still dwarfed compared to the reach of CBS, NBC, ABC, et al.

All in all, I do think Roku and Netflix will end up being the big winners - they're the ones that will survive to see 2020.

[Jsaon schmidt]

I believe apple, netflix and akamai are all profitable.

[Leegaupp]

Just started reading your blog and like what & how you write. I'm 40+ and our family (wife 40, kids 18/16) has had no landline for many years. We "cut the cable" 2 years ago and the only grief we have is being able to legally access content we want via IP. With the new ESPN channel coming on xboxlive and more things showing up on Netflix, as well as Roku and other hardware makers, I truly think the main streams of content delivery need to be aware - the consumer is tired of paying for mediocre content and online streaming of content allows the consumer to pick and choose what they want. I think online streaming will continue to soar.

[Ignorant Investor]

Dan,

Good post. Your point on the importance of knowing the nubmer of Internet connected living rooms is well taken. Do you have any data and/or predictions for Internet enabled TVs (via 3rd party devices like Roku or directly to the TV) in the US and worldwide? Thx.

[Dan Rayburn]

Yes, here are some links to device numbers/estimates:

http://blog.streamingmedia.com/the_business_of_online_vi/2010/02/internet-enabled-tvs-are-not-a-big-deal-for-the-video-industry-heres-why.html