Netflix is Obsolete to This Star

By Michael Carter - August 3, 2012 | Tickers: CSTR, NFLX | 0 Comments

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It’s amazing how when stocks are doing well, they are doing really well, and when they turn bad, they turn really bad.  It was almost a year ago in July of 2011 that Netflix, Inc. (NASDAQ: NFLX) hit an all-time high of $304.79 per share.  Today, Netflix is trading under $60 per share and doesn’t show signs of any changes in the near future that would boost the shares back to triple digits.  The fact is that Netflix’s huge roller-coaster drop happened because, in the past year, it has become obsolete.

Recent Earnings

Even though Netflix reported earnings of $0.11 per share last week versus expectations of $0.05 per share, investors don’t bet on today, but the future.  The future of Netflix doesn’t look good and recent company guidance cemented that theory.  They will blame the Olympics and other things that are preventing new customers from joining or current customers from staying.  However, there are two separate things occurring.  First, the product they provide – streaming video content and DVDs – is getting worse.  Second, the competition is improving quickly.  Having one of these two trends occur can be a disaster for any business.  But, having both occur simultaneously can quickly spell doom.

Disaster Begins

The other day I was thinking about my time with Netflix in mid-2011, when the company was the topic of conversation every week on the various stock market shows as being the next best thing in the equity market.  I first used the free trial they offered with my PS3.  I thought it was fantastic and decided to continue to pay the monthly fee.  The ability to use the PS3 to quickly watch tons of movies and TV shows, on top of the games I had, at the click of a button, all for a low price of $7.99, seemed too good to be true.  You also had the option to get DVDs by mail in addition to streaming in a combo package that came out to about $10 a month total. 

Then the price changes occurred, separated streaming and DVD pricing, and this made the entire pricing system even more confusing for customers.  Then there was discussion of doing away with the DVD mail-service program altogether to just provide streaming.  Then there was a decision made to split its DVD-by-mail service from its moving-streaming business and call that separate business Qwikster.  Then that decision was reversed, which led everyone – shareholders and customers alike – to believe that Netflix had lost its direction.  If things couldn’t get worse, after they raised prices and turned the stock towards the abyss, they lost their contract with Starz.  All of these events occurred in the same year – last year.

The Competition

Blockbuster LLC, formerly Blockbuster Inc, filed for bankruptcy on September 23, 2010.  During this same week Netflix went from $140 to $160 per share and would start its climb to new heights of over $300 per share.  Movie Gallery and Hollywood Video had already gone bankrupt earlier in 2010.  These were some of the big competitors that Netflix was easily able to defeat simply because the Netflix business model was superior.  Why drive to a brick & mortar store when you can have DVDs mailed directly to you or have them streamed directly to your entertainment device?

The Competition Rises

Who would have thought that the company whose original business model of converting loose change into paper currency would be Netflix’s biggest foe today?  In February 2009, Coinstar (NASDAQ: CSTR) purchased Redbox outright for $175 million from McDonald’s, making it the sole owner.  In doing so, Coinstar was able to use its huge brand presence to build up Redbox.  Redbox today has over 35,000 locations.  What is interesting is how different the net income to common shares has changed between Coinstar and Netflix the past four quarters.

There are many reasons this occurred, but in my opinion it all comes down to price and content.  Netflix is obsolete in every way.  In a time when customers want products customized for their use and priced based on their personal needs, Netflix falls flat.  I canceled Netflix late last year after they made changes to their content and started removing shows and movies due to contract issues.  Some content actually cost Netflix a lot.  For them, it just doesn’t make sense to provide content for a price at which they can’t make a profit, let alone make their money back.

Coinstar’s Redbox makes more sense for the average customer.  You pay when you want to watch a movie.  At $1-2 per movie, the control is put back into the customer’s hands.  When I was a Netflix member, I found myself trying to play catch up; I would run Netflix even if I wasn’t in the room just to make me believe I was getting my money’s worth, even though it is all really a sunk cost in the end.  Another feature I think will help build the momentum of Redbox is that there are locations literally everywhere.  They are outside grocery stores and drug stores.  If you want to rent a DVD for the kids on a road trip, you can get a DVD in New York and return it to a Redbox kiosk in California.

Future

In August 2010, Netflix made a five-year deal worth $1 billion to stream movies from Paramount, Lionsgate, and MGM.  The deal hurts Netflix because it increases Netflix's already huge contract fees by over $200 million per year on top of what they already pay to other providers.  Several cable TV providers and other popular vendors also provide their own version of on-demand-programming, which adds pressure to Netflix to either expand its business model, increase exclusivity contracts with top movie companies, or modify something else in order to attract more customers and keep current customers from jumping ship.  In the end, for the customer, it comes down to how much the product costs.  The more customers need to pay for lower quality content, the more obsolete Netflix will become.

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