Customer POV – Amazon Vs Netflix

Customer POV – Amazon Vs Netflix
NFLX Photo by Matt Perreault

A great many tech companies, Amazon is the most famous example and Snap is one of the most recent, are valued on what I call an “and then you pull the switch” basis. By this I mean during phase one the company’s goal is to build market share. During this phase, the market focuses on subscriber growth and locking in subscribers, not current cash flow. Then in some future phase two, the company is assumed to “pull the switch” and start making big profits from those locked in subscribers. Ironically, 20 years after its IPO, Amazon is still widely interpreted as being in phase one.

 

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The critical valuation question is whether there will actually be a phase two in which the company pulls the switch and raises prices to customers and advertisers and, thereby, starts generating big cash flows or whether counterparties will pull their on switch and jump to another company. I think Netflix is particularly vulnerable in this respect. I do not see the customers being locked in sufficiently to justify the company's massive multiple of 230. It is too easy for customers to switch if Netflix raises prices.

In all of this it is critical to remember that value comes from cash flow, not customers. For a comapny to have huge value today with small current cash flow, the switch they are planning to pull must be a big one indeed. And when that big switch is pulled all the customers must stay with the company.

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Bradford Cornell is an emeritus Professor of Financial Economics at the Anderson School of Management at UCLA. Prof. Cornell has taught courses on Applied Corporate Finance, Investment Banking, and Corporate Valuation. He is currently developing a new course on Climate Change, Energy and Finance. Professor Cornell has published more than 125 articles and four books on a wide variety of topics in applied finance. Professor Cornell is also a managing director at BRG where he heads the practice on Climate Change, Energy and Finance. In addition, he is a senior advisor to the Cornell Capital Group and to Rayliant Global Advisors. In both capacities, he provides advice on fundamental investment valuation.
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