Netflix: A Cautionary Tale with Solid Alternatives

By Douglas Ehrman - August 23, 2012 | Tickers: CSTR, CMCSA, FB, NFLX, VZ | 0 Comments

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As the anniversary of Netflix’s (NASDAQ: NFLX) cataclysmic fall from grace approaches, investors may gaze upon the stock and realize that even a full year later, this is not a company to buy.

While the entirety of the company’s 77% tumble did not occur on Sept. 1, 2011, that is the date that everything changed for this once-darling of Wall Street. Prior to that fateful day, Netflix was the next hot thing and a must-have technology stock. Not only did the company provide a new and exciting way to obtain home entertainment, it did so while still offering excellent customer care and expanding technology options.

The stock experienced a meteoric rise from the low $20 range in early 2007 to its peak on July 4, 2011 at $295.14. Today Netflix trades in the mid-$60 range and has lost the remainder of its credibility thanks to more hype that was followed by more disappointing figures. Ultimately, as Netflix competitors keep charging ahead, one of these alternatives is a better bet for one’s investment dollar.

Please Rewind

While the Netflix story may well end up as a business school case study on how to destroy a good thing, it is widely known to Wall Street and Main Street alike. Facing pressure from the increased costs of renegotiated content contracts, the company announced a change in its pricing model. The change resulted in a price increase of roughly 60% for many customers, many of whom expressed their disgust by canceling their subscriptions.

CEO Reed Hastings publicly admitted the misstep and then followed it up with several more. First, the company planned to spin off the DVD side of the business and give it a new name. Then realizing that customers did not want to manage multiple accounts, the plan was scrapped. Then the video game segment would become independent. Then… The plan went through so many iterations that the only thing that remained certain was that investors had lost their faith.

Fast Forward

After languishing in a slow march lower, some of the hype returned to the stock when Mr. Hastings announced in late July 2012 that streaming video usage by Facebook (NASDAQ: FB) subscribers had surpassed one billion hours in the previous month. The news led to a nearly 25% pop in the stock on the assumption that the company’s subscription base had grown substantially. When earnings were subsequently released, the numbers showed that while streaming subscriptions had grown, the increased revenue was insufficient to cover the continuing losses from canceled DVD subscribers. Additionally, the last vestige of the company, international subscriptions, had not grown as fast as hoped either. If Netflix had any credibility left before this most recent report, it is hard to imagine that any remains today.

Push Play

While competition for the space is fierce and there are many players, the two biggest threats to Netflix in the immediate-term are Comcast (NASDAQ: CMCSA) and the offering that results from the alliance between Verizon Communications (NYSE: VZ) and Coinstar’s (NASDAQ: CSTR) Redbox. While Comcast is known for providing the worst customer service in the industry, its Streampix service is being offered as a free addition to any customer that has a high enough subscription level. The service does not offer the same breath of coverage as Netflix, but with Comcast’s reach with content providers, that may change going forward. Furthermore, the addition of the service may convince customers that were considering cutting their service in favor of Netflix plus a lower-cost subscription to remain at the higher level. More bad news for Netflix.

The offering from Verizon and Redbox has yet to be rolled out, but early indications suggest that it will offer a combination of streaming service and a set number of rental days from Redbox kiosks. Anyone doubting the efficacy of the Redbox model should consider that over the past year Redbox has rented nearly 720 million discs generating approximately $1.7 billion in revenue. The loyal following of Redbox users are largely known for their dissatisfaction with other options. The belief is that this contingent may be rapid adopters of the new service and give it an immediate market presence. Again, more bad news for Netflix.

The End

Despite the constant fumbling, there are still analysts that see opportunity in the Netflix maelstrom. The company continues to expand its offerings in Europe and is aggressively pursuing new markets. Unfortunately, these pursuits will need to perform almost flawlessly in order for the company to stem the tide that has seen it fall further into the abyss; flawless performance is not a hallmark of this company. As home entertainment becomes a race to provide content, service and portability, there are simply better options for one’s investment dollar.

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