Commentary > The Bottom Line  
Making money on Netflix
Finally -- an Internet IPO that makes sense.
March 11, 2002: 7:56 PM EST
By Adam Lashinsky

SAN FRANCISCO (CNN/ - In Woody Allen's 1980 film "Stardust Memories," Allen plays a filmmaker intent on making serious films. His fans liked the previous, funny, ones, however, and implore him to return to his comical roots.

Similarly, this column always has aimed at skepticism, the idea being that it's Wall Street's job to cheerlead while the journalist's job is raise red flags. But every now and then there's an opportunity to be hopeful...

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And so here's an Internet IPO that actually looks enticing: Netflix, the mail-order DVD company.

Netflix just filed its documents to go public last week, so the IPO is months off. And because companies file pricing information only after an SEC review, it's impossible to know how audacious Netflix's bankers will be in the valuation they set.

Having said that, there's a lot to like in what Netflix does. For $19.95 a month, subscribers get the privilege of keeping three DVDs as long as they like. When they return a DVD -- in the easy-to-deal-with return envelope -- Netflix send out the next film on the subscriber's Web-based wish list.

Its 2001 revenues of $76 million reflect real demand, much of it in the San Francisco Bay area, where Netflix reports that 2.6 percent of all households are subscribers. Nationwide, subscribers totaled 456,000 in 2001, up from 292,000 the year before.

Neat stuff in Netflix's financial picture include its relatively low costs: The gross profit margin of 34 percent reflects potentially profitable purchasing deals with several Hollywood studios, who, naturally, have a small equity stake in Netflix. This company is losing money, of course. But the idea is that scale will make up for the modest fixed costs.

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Also worth noting is that Netflix last year adopted more conservative accounting practices. By choosing to "expense" the purchase cost of its films, Netflix's operating results take an immediate hit, as they should. This slows the push to profitability, but investors don't have to worry about huge writedowns of inventory a few years (or quarters) down the road.

So is this a slam dunk? Of course not. Friends report their love of the service, and I think if I were to buy a DVD player I'd likely sign up. But the Wall Street Journal reported Monday that of 381 Internet IPOs between 1999 and 2001, only 56 trade above their offering price. And the competition will be intense and the thrill may wear off.

Yes, it's very cool that Netflix will keep a list of movies I want to see and mail them out on a regular basis. But buying books from Amazon also was a lot cooler a few years ago than today. I was an enthusiastic Amazon customer in 1997. Today, if I need a book, I'm just as likely to go to the book store.  graphic