The Streaming Video Model Is Here to Stay

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

Let’s talk about our favorite Internet streaming service, Netflix (NASDAQ: NFLX), the competition, and the strengths and weaknesses of the company.

Strengths

  • Innovative first mover into DVD rentals by mail, and then streaming. Willing to cannibalize its DVD business and not stick with the status quo.
  • Reed Hastings recently stated that retention amongst newly acquired Canadian subscribers is high, and that the company is seeing steady subscriber growth in the country.
  • Recent $300 million a year deal with Disney (NYSE: DIS) will include Pixar animation, and recently acquired (by Disney) LucasFilm productions (Star Wars.) This raises the value of their streaming library.
  • Morgan Stanley, in a recent report, stated that Netflix has more pricing power than the general market believes, as they differentiate their portfolio of videos. However, with the 2011 Quixster fiasco, I'm not sure that Reed Hastings will be raising prices anytime soon.
  • Generally very good customer service, and superior platform to Amazon (NASDAQ: AMZN) Prime Video (one of the major competitors bears have been fearing) where free videos for Prime customers are interspersed with ones you must pay for. 
  • Best library of streaming videos on the Internet.
  • Dish Networks, which bought the remnants of Blockbuster, had plans to enter the streaming market using the Blockbuster name, but pulled back. The CEO (I believe) complained that Netflix got a sweetheart deal for content. This not only eliminates (at least temporarily) another competitor, but illustrates first mover advantage into a field.

Weaknesses

  • In the UK and Ireland, Netflix is competing with SKY and Lovefilm, which is a much more daunting task than the negligible competition in Latin America.  The company is still in the red in the UK market, and will have a tough time turning a profit there.
  • Management, who I basically believe in, made a major misstep in 2011 with the Quixster debacle. Hopefully the company will respond with better customer communication. However, the misstep will lessen management's willingness to raise prices. 
  • It has to be mentioned, the ultra-high PE ratio is due to vast amounts being invested in international expansion. Personally, I’m okay with this, but it makes the stock vulnerable to a rapid downturn if they have bad results.

Threats

  • Has had a hard time processing electronic payments in Latin America.  According to CEO Reed Hastings that is partly due to households being leery of supplying credit card information over the Internet.
  • Netflix's competition against SKY and Lovefilm in the UK and Ireland is a threat as well.
  • The Coinstar (NASDAQ: OUTR) and Verizon (NYSE: VZ) partnership, "Redbox Instant" is not yet a viable threat to Netflix at this point in time.  First of all, the video library is far more sparse, only 10% according to this article, and does not include any TV shows, only movies.  Also, if you turn in a DVD after the prescribed time (four nights) you will be charged a late fee.  I do not believe that too many consumers want to go back BlockBuster model of renting. However, just because I won’t be switching (I like watching old TV shows for one) doesn’t mean some people won’t. If you’re a Netflix investor, I would however keep an active eye on this to see if they expand their library.
  • Amazon will be more of a threat only when they upgrade their platform and video library. Bezos certainly has the willingness and chutzpah to do this however. I currently subscribe to both Prime and Netflix, and though I originally thought I could replace Netflix through Prime, have since rejoined Netflix.
  • Google (NASDAQ: GOOG) - While Google could potentially buy out Netflix, and wouldn’t be a bad acquisition for them, having YouTube and now having invested in differentiated content from known Hollywood players, could pull eyeballs from Netflix. Google Play has a streaming service, and if they were to expand the library to all you can eat model for one price, combined with YouTube, this could spell disaster for Netflix.

Opportunities

  • International expansion is progressing, and according to the latest quarterly conference call is doing well.
  • Recently expanded to Scandinavia, including the countries of Norway, Denmark, Finland, and Sweden.  Has said that the initial results there have been positive.
  • The company has announced it expects quarter for of 2012 to be its peak of international losses. (this is at least partly due to marketing and other investment costs not being countered by subscription revenue.
  • A bill that would allow the sharing of video rental history that is backed by Netflix passed the U.S. House of Representatives in a vote yesterday. (it failed last time it made its way through the House)
  • Its own proprietary content. Netflix has invested a ton in this, and their first offering of Lillyhammer was surprisingly good and that alone made me feel was worth keeping my $8 a month membership. Netflix has more original programming coming out, and the stakes are HIGH, as Netflix really paid through the nose to get these shows.  Big opportunity, but the risky nature of production of entertainment leaves little margin for error. If successful it will give them the ability to raise prices as their library will be differentiated and of greater value to consumers.
  • Could enter into e-commerce section somehow/ also the pay per view model for movies not included in streaming library, which would keep customers at home and raise revenues.

Final Thoughts

In the past I was with the consensus opinion that competition was going to eat away rapidly at Netflix’s market share. However, no one has demonstrated themselves to be a truly viable competitor with Netflix streaming despite having had a decent amount of time to ramp up their offerings and platform. I have changed my mind, and become a long term believer in the viability of Netflix’s business.

However, with the recent run up in the stock, it is not as attractive an investment as it was at lower prices. The relatively high valuation leaves it vulnerable to a large pullback. I would wait for one before diving in.

If anyone out there has a well thought out, contrary opinion, please feel free to leave a comment below.


margiecfl has a long position in Google. The Motley Fool owns shares of Amazon.com, Walt Disney, Google, and Netflix. Motley Fool newsletter services recommend Amazon.com, Walt Disney, Google, 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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