Big Risks and Opportunities in Netflix

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Shares of Netflix (NASDAQ: NFLX) were falling by nearly 15% after the company reported earnings on Monday after the close. The negative reaction from investors looks like an exaggeration, since the data wasn’t so bad after all. On the other hand, there are still many doubts about the company´s ability to compete against bigger and powerful rivals in the following years.

Looking at its latest earnings report, Netflix seems to be making progress on the dramatically important subject of customer growth, especially in streaming.  From the company´s press release:  Netflix added nearly 3 million streaming members in Q1, bringing our total to over 26 million global streaming members, and strengthening our position as the world’s leading Internet TV network.

That is a good sign for investors; the company had lost many customers when it decided change its pricing structure last year in a move that turned out to be very detrimental for Netflix and its share price. This last quarter seems to confirm what we saw in the previous one, that Neflix is regaining customers and growing again.

Some analysts were disappointed to see negative cash flows from the DVD rental operations, but that won´t be a game changer for Netflix in the following years. The company has already decided it wants to bet strongly on streaming and will do its best effort to convert DVD subscribers to streaming as quickly as possible.

Maybe Netflix is rushing too much into converting customers from DVD to streaming. Coinstar (NASDAQ: OUTR) has recently upgraded its sales and earnings guidance for the first quarter, signaling that DVD rentals is still a profitable and growing business. Coinstar raised sales guidance to the $567-$569 million range versus a previous guidance of between $530 and $555 million, guidance for core earnings was raised to $1.36 - $1.40 per share from a previous guidance of  $0.76 -$0.91 for the quarter.

There is not much doubt about the fact that streaming has many advantages over rentals, so sooner or later the industry is moving in that direction. Even Coinstar, which is quite successful in its DVD rentals, is partnering with Verizon to enter the streaming business. It looks like Netflix may be moving away from DVDs too fast, and maybe Coinstar is taking a better approach by giving customers the time to gradually move from rentals to streaming instead of pushing that move via price increases like Netflix did.

The future of the business is going to depend on streaming and Netflix is still well positioned in that industry. The problem is that competition is going to increase rapidly, and it’s coming from powerful competitors. Amazon (NASDAQ: AMZN) is a particularly fierce challenger, and it has demonstrated in the past that the company is not afraid of cutting prices to gain market share.

Amazon is going after Netflix with its Amazon Prime service, and things could get nasty for both companies if the competition heats up in terms of pricing and customer acquisition costs. Netflix may have the first mover advantage, but Amazon has deeper pockets and a huge customer base.  Amazon doesn´t need to make money from video streaming as long as other businesses keep generating cash flow, but the situation for Netflix doesn´t seem to be so flexible.

Competition is hard and going to get harder, we can read on this subject from Netflix´s letter to investors:

We compete for consumers’ viewing time with a very wide range of video sources, including linear TV (MVPD and free-to-air), DVR, over-the-top (OTT) pure plays such as Hulu and Amazon Prime Instant Video, and authenticated streaming offerings of the MVPDs and cable networks (TV Everywhere).

As we’ve often said, we see the biggest long-term competition for viewing hours from MVPDs and cable networks through their TV Everywhere offerings. Consistent with this view, we began to see the consumer promise of TV Everywhere emerge in Q1, with all major networks and many MVPDs investing in their Internet applications and taking steps to evolve to Internet TV networks. Among recent developments, both HBO GO as well as Comcast’s Xfinity application became available on the Xbox. Additionally, Comcast announced its Streampix streaming service available to current Comcast subscribers. Given the superiority of our content selection, user interfaces and device ubiquity, we don’t currently see any meaningful near-term impact on our business from these developments

The negative reaction from the latest earnings report was widely exaggerated; the company is growing subscribers again and the loss isn´t so bad considering that Netflix is investing heavily in transitioning subscribers from DVD to streaming and geographic expansion. From that point of view this last price collapse may be a buying opportunity for long term investors.

On the other hand, concerns about growing competition are still very important in the middle and long term. I would wait a few months and see how Netflix handles the competitive landscape before placing a buy order on these shares. Disruptive leaders are sometimes disrupted themselves by bigger companies with more resources. I´ve seen that movie before.

acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of Motley Fool newsletter services recommend, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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