Netflex Case Study

FRC: Netflex

This cases discusses how Netflex generated certain risks with its strategic shift in its business model from offering physical DVD rental subscriptions to offering a combination of streaming and physical DVDs, streaming being the main focus.

For this assignment, you can use the financials in the Excel spreadsheet posted above.  Please note that the Excel spreadsheet above includes quarterly data from 2008 to 3Q 2011.  Exhibit 3 in the case is based on annual data from 2002 to 2010 and quarterly data in 2011.

1. How has Netflix performed over the last three years?
2. Over the past 3 years,  though the profit margin (over revenue) has increased from 6% to 8% but D/E ratio (increasing fast) shows that the company has generated debt increasing while ROA (declining)ratio shows that the management has not utilized its assets to generate return efficiently
3. What risks does Netflix face as it changes its business model to rely more on streaming content?  Where are these risks presented in its financial statements?  Use the case and excerpts from Netflix’s 10-K financial statements given above.

Risks:

Balance sheet：

• while high prepaid expenses and prepaid revenue indicates that the company is investing heavily in the company’s growth it also exposes the company’s big risk should there be significant decline in future user subscriptions
• Starting from Q3/2010, the company’s current liquid assets( cash+ST investments) cannot no more cover its current liabilities.
• The company is generating significant liability to invest in growth

1. What criteria should drive the rate of content amortization?  Do you agree with the concerns expressed about the declining rate of content amortization by Netflix?

      From the case, DVD: sum-of-the-month amortization method

                         Streaming: straighline

Sum-of-the-month amortization (accelerated) will impose higher amortizations in the early months and lower amortizations in the later months. While Straightline amortization will impose the same amount of amortization each year over the lifetime of the contract.

Higher amortizations in the early years are aligned with the expected usage of the digital contents, as new releases generally have more audience than back-catalogue contents. So from the perspective of aligning accounting method with economic reality, amortizing on straightline does not obey this principle.

1. How different will Net Income (before tax) be in 3Q 2011 if Netflix followed the same content amortization policy as they did for DVDs? 

[pic 1]

[pic 2][pic 3] This is Amortization under straightline. If using the same DVDs’ sum of the month amortization method, amortization amount will go up and pre-tax net income will decrease a lot.

1. How would you assess the extent of risk posed by the off balance obligations of Netflix?

As a comparable example, a manufacturer has just established a contract which agrees to purchase 1mln gadgets at 1 dollar each over the upcoming 4 yours. It would not record a liability of 1 mln on day one to reflect that contract. Instead, it would record  liabilities as those widgets are being produced and delivered over the five year period. However, it would be recorded in the notes attached to the financial statements so that investors have a sense of what is coming up during the upcoming years. A big number in this category is not necessarily a sad thing. In many occasions it can be a very good thing, indicating that leaders in the company are investing heavily in the company’s growth. I think it is more meaning to look back at the company’s historical and current financial ratios including ROE, ROA, ROIC to get a better sense of the performance of the company’s management and operations.