fin300 final team project

And Now for the Bonus Round…What are the Two Ways Netflix Delivers

Movies?

Merger and Acquisition Audit Assessment and Proposal for the Netflix Corporation

by L JANS & Associates, LLP, Lead Consultant

A PowerPoint Presentation to Meet Partial Requirements for Managerial Finance 300 A

Course Professor: Mr. William Sarsfield

Members of L JANS and Associates, LP: Hiu Man Chan (Alicia), Jenny, Licia, Nina, & Scott

Friday, May 06, 2011

Table of Contents:

I. Executive SummaryII. Organizational Profile Facts and Figures: Netflix and Targeted

EnterprisesIII. Statistical Market Data and Information: DVD Rental and Internet

Streaming for Consumer and IndustryIV. Du Pont Model Report AnalysisV. Balance Sheet Report AnalysisVI. Liquidity and Probability Metrics Report AnalysisVII. Consultant’s Closing Audit Assessment and Final RecommendationVIII.Open Session: Q & AIX. References

Disclaimer: Some of the names and events in this report are fictitious and their sole purpose is ancillary in nature to actual data and information under analysis.

Portraying the role and function of an accounting consultancy firm, we, L JANS and Associates, are attempting to provide auditing and M & A evaluation services, at the request of our client, Netflix.

In addition to performing a comparative auditing assessment between Netflix, Inc. and the Comcast Corporation, Netflix has also made a formal request to execute due diligence evaluation analysis for two potential acquisition candidates: Redbox Automated Retail (a subsidiary of Coinstar, Inc.) and Blockbuster, Inc.

Before our final recommendation is rendered and officially submitted, L JANS & Associates will describe the current financial and overall health of the company, as it is compared against both its preferred targets and industry.

Consultant’s Goals and Objectives:

1. Provide primary and secondary auditing services for client

2. Execute and create a comparative performance analysis portfolio

3. Perform due diligence analytics on acquisition targets, including contingency plan suppositions

4. Deliver closing arguments and final recommendation

Executive Summary

I. Organizational Profile Facts and Figures: Netflix and Targeted Enterprises

Netflix Company Portfolio:

◊ Movie rental provider of DVDs and online streaming

◊ Founded in 1997 in Scotts Valley, CA., by Marc Randolph and Reed Hastings

◊ Netflix maintains the largest library of online content

◊ DVD By-Mail Subscription base currently covers both U.S. and Canada

Companies Involved in Report Netflix, Inc. Comcast Corp

Redbox Automated Retail, LLC (Wholly-owned

subsidiary of Coinstar, Inc.)

Blockbuster, Inc. (Wholly-owned

subsidiary of DISH Network Corporation)

Headquarters Address:

100 Winchester CircleLos Gatos, CA 95032

United States

One Comcast Center Philadelphia, PA 19103-2838

USA

One Tower Lane Suite 1200 Oakbrook Terrace, IL 60181

United States 1201 Elm Street Dallas,

TX 75270 USADate of Incorporation:

August 1997 , DE, United States

December 2001 , PA, United States Founded in 2004

October 1989 , DE, United States

Number of Employees: 4,329 102,000 CoinStar: 2,585 48,000

Chief Executive Officer: Reed Hastings, Chairman

& CEO Brian Roberts, CEO

Coinstar: Paul Davis, CEO: Redbox: Mr. Mitch Lowe,

President Bruce Lewis, SVP & CFOGross Revenue: $2.2 billion $38 billion Coinstar: $1.6 billion $3.5 billion

Exchange Listing:NASDAQ NASDAQ Coinstar: NASDAQ Delisted

Symbol:

NFLX

CMCSA-Class A Common Stock: CMCSK-Class A Special Common Stock Coinstar: CSTR Delisted

Firms Profile Facts and Figures: Netflix and Targeted Enterprises


◊ Future expansion projects underway for Europe and Spain by Year-end 2012

◊ 1 million DVDs mailed each day contained in 35,000 different titles

◊ Developer of the innovative video-recommendation algorithm called Cinematch: “The Netflix Prize”

◊ CEO Reed Hastings – Facebook’s newly assigned Board of Director member in 2011






Number of Outstanding Shares (as July 17, 2011): 52,782,000 20,391,697 Coinstar: 31,355,000 219,000,000Number of Institutions Holding Shares: 539 (Up) 217 773 Coinstar: 275 3Current 52 Week High/Low: $297.35/$95.33 $27.16/$16.76 Coinstar: $67.56/$37.80 $0.28/$0.03

Most Recent Dividend Distribution Amount:

Netflix has never paid a cash dividend on capital

stock. July 1, 2011 @ $0.113

Coinstar has never paid cash dividend on capital stock.

Coinstar is restricted to pay any cash dividends under its current

credit facility. June 2, 2005 @ $0.02

Historical Stock Splits:

Executed 2-for-1 stock split February 12, 2004.

Executed 3-for-2 stock split February 22, 2007; 2-for-1

split May 6, 1999: 3-for-2 February 3, 1994; 3-for-2

split October 25, 1989. Coinstar: None None

Facts and Figures Continued…


◊ The company went public on May 20, 2002; IPO trading began on May 24, 2002

◊ Actual offered price @ $15.00; Opened @ $16.19 and closing up 3.5% at $16.75

◊ IPO raised $94.5 million

◊ Underwriters: Merrill Lynch; Pierce, Fenner, & Smith Incorporated; Thomas Weisel Partners, LLC; U.S. Bancorp Piper Jaffray






Notable M & A Historical Events:

Coinstar purchased 47% of Redbox in 2005: Later in 2009 purchased the remaining 53%

stake in Redbox.

Current Status:

Public Public

Publically held as a wholly-owned subsidiary of Coinstar,

Inc.- Parent Company

Chapter 11: Purchased by DISH via section 363 of

the US Bankruptcy Code following official Chapter

11 filing in September 2010

Miscellaneous Notes:

Coinstar sold their Entertainment business in

September 2009, roughly nine months following the purcahse

of the remaining stake in Redbox in January 2009.

Facts and Figures Continued…

“A Virtual Catch-Up Effect for Content Distribution in the Internet World”

◊ Product lifecycle curve: Moderate to sharp nascent growth, followed by decline to equilibrium

◊ Convergence between Revenue and Growth accelerated after reaching its peak in 2000

◊ Convergence Consultancy Group of Toronto estimates 1% cable and satellite subscription cancellations by Canadians by the end of 2012

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110

10

20

30

40

50

60

70

80

90

0.00

5,000.00

10,000.00

15,000.00

20,000.00

25,000.00

30,000.00

35,000.00

40,000.00

45,000.00

0

84.8

71.3

47.3

12.8 13.115.8

20.2 20.117.2

26.5 24.918.8

Internet Publishing and Broadcasting in the U.S.

Revenue $ million

Growth %

U.S. Internet Market Data and Information:

◊ Netflix ranked 4th for percentage of VOD upstream traffic in 2010

◊ In January 2011, viewers on average spent 4 hours and 39 minutes watching Internet video, an increase of 45% from a year earlier

◊ Netflix members instantly enjoy unlimited movies and TV episodes streamed over the Internet to PCs, Macs, and TVs

◊ Devices streaming from Netflix are Microsoft Xbox 360, Nintendo Wii, and Sony’s PS3

1. B

itTor

rent

2. H

TTP

3. G

nute

lla

4. N

etflix

5. S

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6. S

SL

7. Y

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e

8. M

GCP

9. P

PStream

10. F

aceb

ook

34.31%

12.36%11.18%

4.34%3.28%2.99%2.47%2.46%2.41%2.28%

Upstream Percent of Traffic: Year-End 2010

Upstream Percent of Traffic

U.S. Internet MD & I Continued…

◊ Ranked 2nd for percentage of VOD downstream traffic

◊ Download streaming exclusively uses Microsoft’s Silverlight playback technology

◊ Google’s Chrome OS plugins will become available for like users to stream video on Netflix in 2011

◊ Real-Time Entertainment traffic accounted for 45.7% average daily content downloading in N.A.

◊ “Social Apponomics”: Netflix’ $1.3 billion online movie rental service with 15 million subscribers

2. HTTP

4. Netflix

7. YouTube

1. BitTorrent

0. Flash Video

0. RTMP

0. iTunes

10. Facebook

3. Gnutella

0. Xbox Live

22.70%

20.61%

9.85%

8.39%

6.14%

6.13%

2.58%

2.44%

2.12%

1.61%

Downstream Percent of Traffic: Year-End 2010

Downstream Percent of Traffic


◊ Achieves the highest % differential increase between upstream and downstream among ranking qualifiers

◊ Three-tiered downloading bandwidth approach: Low, Middle, High

◊ Once a 1:1 ratio, dollar-to-video time (hourly) for subscription packages; Now, unlimited video streaming at no additional charge

Applic

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n

1 BitT

orre

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2 HTT

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3 Gnu

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9

4 Net

flix

2

5 Sky

pe 0

6 SSL

0

7 You

Tube

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8 M

GCP 0

9 PPStre

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10 F

aceb

ook

8-75.55%

83.66%

-81.04%

374.88%

0.00% 0.00%

298.79%

0.00% 0.00%

-0.81%

Netflix: Top-Ten Internet Traffic Performance Analysis: Year-End 2010

Percentage Difference in Ranking (Upstream vs. Downstream) ± Series2


◊ Netflix shares are held by 570 institutions: Accounting for 87.05% of all shares held.

◊ Among the top 5-10 institutions are the following: ▪ Vanguard Group, Inc. ▪ American Centuries Companies, Inc. ▪ State Street Corp ▪ Blackrock Institutional Trust Company ▪ Bank of New York Mellon Corp

◊ Irrational Expectations: Investors reaction to the company’s new subscription price increase

◊ Stock price increased 219% in 2010

Du Pont Model Report Analysis

◊ Product paradigm shift from DVDs to online movie and TV shows streaming

◊ Content obtained from studios via fixed-fee licenses, revenue-sharing pacts, & direct purchases.

◊ Added 8 million subscribers in 2010, bringing total to 20 million

◊ In 2010, revenue catapulted up 29%: Net income up 39%

Balance Sheet Report Analysis: Netflix, Comcast, Redbox (Coinstar), Blockbuster

◊ Steady increase in liabilities is partially due to domestic and international expansion

◊ Netflix’ “Watch Instantly” first-run rights to films from the following companies:

▪Paramount Pictures; MGM; Lions Gate Entertainment; Sony Pictures; Walt Disney Motion Pictures; First Look Pictures; Relativity Media

◊ Netflix’ “Watch Instantly” back-catalog rights to films from the likes of Time Warner, Universal Pictures, 20th Century Fox

Balance Sheet RA Continued…

Three main factors that identify and explain the large disparity between Netflix’ ROIC and M/B ratio and that of its targeted entities:

1. One stock split in mid 2000 and the avoidance distribution of cash dividends

2. Consequential and direct correlation from previous actions stated, marginal annual rise in stock price

3. Favorable long-term content licensing fees arrangements and gradual shift to online distribution

Performance Measures Comparison Chart (%, unless noted otherwise), as of Year End 2010 Netflix, Inc. Comcast Corp


subsidiary of Coinstar, Inc.) Blockbuster, Inc.

NOWC (Net Operating Working Capital) 116,192,000 1,880,000,000 -125,461,000 198,800,000

TOC (Total Net Operating Capital) 244,762,000 25,395,000,000 319,226,000 448,200,000

NOPAT (Net Operating Profit After Tax) 170,185,000 4,788,000,000 85,924,200 -213,120,000

FCF (Free Cash Flow) 103,767,000 -463,000,000 92,174,200 -115,820,000

ROIC (Return on Investment Capital) 70% 19% 26.92% -48%

Market/Book (M/B) Ratio 50.20 1.15 9.54 -2.70

Solvency and Profitability Metrics Report Analysis

Sample Illustration of Liquidity and Profitability Matrix Worksheet

Netflix Liquidity Measures: Year 2010

Net Operating Working Capital (2010) = Operating Current Assets − Operating Current Liabilities

= 375,505 − 259,313 = 116,192 Conversion 116,192,000

Net Operating Working Capital (2009) = Operating Current Assets − Operating Current Liabilities

= 171,553 − 124,862 = 46,691 Conversion 46,691,000

Total Net Operating Capital (2010) = Net Operating Working Capital + Net Operating Long-Term Assets

= 116,192 + 128,570 = 244,762 Conversion 244,762,000

Total Net Operating Capital (2009) = Net Operating Working Capital + Net Operating Long-Term Assets

= 46,691 + 131,653 = 178,344 Conversion 178,344,000

NOPAT = Earnings Before Interest Taxes X (1 - Tax Rate) = 283,641 X 0.60 = 170,185 Conversion 170,185,000

New Investment in Operating Capital (Current Year's Total Net Operating Capital - Previous Year's Total Net Operating

Capital) + DepreciationFree Cash Flow (FCF) = (NOPAT + Depreciation) −

= 306,764 − 202,997

= 103,767 Conversion 103,767,000

Return on Investment Capital (2010) = NOPAT ÷ Total Net Operating Capital

= 170,185 ÷ 244,762 = 70%

Solvency and Profitability MRA Continued…

◊ Five-year deal reached with Paramount, Liongates, and MGM worth nearly $1 billion to stream movies

◊ As a result of the deal, annual expenses related to new deal expected to increase to $200 million from $117 million a year earlier

◊ Acid Test Ratio slid ▼36.2% in 2010 from a year ago, because of the addition to current liabilities


◊ Rapid growth of E-Commerce compared to traditional brick-and-mortar facilities has impacted companies like Redbox, Inc. because of product design and limited distribution channel

◊ Blockbuster offers “Total Access” which enables customers to rent movies online, reducing accrual cost liabilities associated with enhanced inventory control and decreased wages


◊ Netflix reported positive net operating profit after taxes and free cash flow for 2010

◊ Conversely, Comcast saw a significant negative total in FCF; nearly half was attributed to an aggregate of new acquisitions during 2010

◊ Although business status is active, Blockbuster incurred negative output for both NOPAT and FCF, as a direct result of preliminary stage of Chapter 11


ROIC and M/B Visual Recap


◊ Netflix’ migration strategic plan transitioning legacy business model (DVD retail) to contemporary business model (Internet streaming) elevates current debt ratio, from previous years, above industry standard

◊ In contrast, fledgling DVD rental market coupled with a limited distribution pipeline results in higher debt ratio for Redbox against the industry standard

7.449.58

3.55

0

4.8

9.6

5.7 4.5

2010 Financial Ratio Comparison: Company vs. Industry

Profit Margin: Company Profit Margin: Industry

70.5%

33.4%63.4%

120.4%

51.9% 53.9% 51.9% 65.2%


Debt Ratio: Company Debt Ratio: Industry


Netflix’ operation efficiency significantly outperforms

acquisition targets with regards to sales, or COGS, to inventory

2.6

0.33

1.15

2.21

10.3

1

2.1


Total Asset Turnover: Company Total Asset Turnover: Industry


Netflix Current Ratio Performance Record:

◊ Netflix efficient SOP (standard operating procedure) throughout its entire supply chain, accompanied by newly increased subscription rates

Netflix ROE Performance Record:

◊ Netflix management decision not to remit dividend payouts

◊ Current stock price 52-week high of $297.35

Netflix, Inc.

Comcast Corp

Redbox Automated Retail, LLC (Wholly-owned subsidiary of Coinstar, Inc.)

Blockbuster, Inc.

1.65

1.08

0.77

1.13

1.1

1.1

1.1

1.4


Current Ratio: Industry Current Ratio: Company

Netflix, Inc.

Comcast Corp

Redbox Automated Retail, LLC (Wholly-owned subsidiary of Coinstar,

Inc.)

Blockbuster, Inc.

65.75

8.35

11.92

0

14.06

7.2

11.4

26.9


Return on Equity: Industry Return on Equity: Company


I. Opinions:

Liquidity and profitability positions are moderately conservative to proactive aggressive and comfortably aligned with corporate business model.

Current integration measures for existing by-mail subscription services to VOD long-run is plausible and should be accelerated.

Because online subscription service over the Internet is experiencing steady yet substantial growth well above industry average, existing short- and long-range migration strategic planning should maintain current course directive for global expansion.

II. Recommendations:

The company’s new migration directive to boost its online presence, in conjunction with a waning DVD rental market, is not conducive to the functionality of a brick-and-mortar business model. Therefore, we recommend that management should not move forward with its acquisition plan of Redbox Automated Retail, LLC.

Because substantial increases in online product and marketability leverage is projected long-run, we highly suggest that all current considerations and long-range plans to acquire Blockbuster, Inc., upon a successful emergence from Chapter 11, should move beyond the exploratory phase to tactical, to specifically capitalize on Blockbuster’s elaborate and expansive distribution network

Consultant’s Opinions and Final Recommendations

Consultant’s Closing Audit Assessment and Final

Recommendation

…“Uuum, Netflix Watch Instantly and DVD?”

“And you are co-o-o-rrect!” “Whoo hoo!”

Open Session: Q & A

Source References: Literary Sources:

Troy, L. Ph.D. (2010 Edition). Almanac of Business and Industry Financial Ratios.

Chicago: CCH Group

Strategy + Business Magazine (Spring 2011, Issue 62- ). The Coming Wave of Social

Apponomics. New York: Booz & Company

Web Sources:

Businessweek.com (N/A). Investing. Retrieved June 06, 2011, from http

://investing.businessweek.com

Sagepub.com (N/A). Sage Online Search. Retrieved June 06, 2011, from

http://0-online.sagepub.com.library.ggu.edu

ReferenceUSA.com (N/A). Reference USA Search. Retrieved June 06, 2011, from

http://0-www.referenceusa.com.library.ggu.edu

Charlie Rose.com (N/A). Guest Interviews: Reed Hastings, CEO of Netflix. Retrieved

June 06, 2011, from http://www.charlierose.com

http://investing.businessweek.com/

http://investing.businessweek.com/

http://0-online.sagepub.com.library.ggu.edu/

http://0-www.referenceusa.com.library.ggu.edu/

http://www.charlierose.com/

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