Netflix (Part 2): Is The Company Its Own Best Sequel?

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

With Netflix (NASDAQ: NFLX) trading at $85, or over 60% above its 52-week low, I’m beginning to wonder how long will it be before the company regains that all important mark of $100 per share. The psychological importance of this is obvious – particularly for a company that once traded at over $300 just a little over a year ago.

Netflix Part 2

For Netflix, merely saying that it’s been on a “bumpy ride” would be an understatement. Not that the company has arrived to its destination just yet – in fact, far from it. But at least, these days investors are able to locate the endpoint on the GPS. A content sharing deal with a company such as Disney (NYSE: DIS) has a way of offering the sort of validation that Netflix has needed - call it a “calming effect.”

Now, although I’m willing to applaud Netflix for executing a series of moves that suggests the company is “turning the corner,” I still worry that it might not be sustainable. In other words, has the company really done enough to completely erase the bear arguments that have damaged its reputation over the past year?

Even though there’s been a slight rebound in the shares, Netflix still needs to prove that its days of self-inflicted wounds are over, many of which were caused by its desire to grow no matter how much it costs. Although the company has shown to have changed in some respects, this part has not.

Unfortunately, at this point last year, its ambitions ended up costing Netflix 1 million subscribers with its ill-timed price hike and its push into movie-streaming. However, the company was right – albeit flawed in its execution.

Today, Netflix wants to convince Wall Street that a second act has arrived and the sequel is much better. I’m not sure about you, but I don’t know many movie sequels that were better than the original – although “The Hangover 2” comes close. But that’s a topic for another time.

Box Office Hit or a Flop

One can’t discuss Netflix’s future without addressing the company’s aggressiveness to expand in international markets. After all, this is where the majority of the company’s profits have gone. That Netflix reported a 90% drop in its net income serves as an example of the costs the company is willing to pay to realize its ambitions. But will it work?

The competition so far is not making it easy. Although Netflix’s deal with Disney will present some leverage, it’s worth noting that Amazon (NASDAQ: AMZN) also signed its own deal recently with Epix. While Netflix remains the clear-cut leader in the streaming business, both Amazon and Apple (NASDAQ: AAPL) have also been gaining some traction. For that matter, so have services like Hulu and YouTube.

However, for Netflix, competition is nothing new. Although this has been the most commonly cited bear argument, the company has proven that it can grow – and grow impressively despite these threats. For instance, Netflix was able to gain 2 million new streaming members in the recent quarter, which has now brought its worldwide total to 29 million.

This is in addition to U.S. subscribers, which grew to over 25 million – up more than 20% year-over-year. Likewise, it is certainly encouraging that 700,000 new international subscribers were added during the quarter – helping the company reach a total of 4.3 million. This is great, right? But hold your applause – to do this, it required (as noted) a 90% decline in profits. Was it worth it?

On the other hand, Amazon also lost $274 million in its recent quarter by aggressively building its infrastructure. While Netflix may find some solace from the Amazon comparison, Prime is only one segment of Amazon’s revenue stream. Still, I don’t think that Amazon’s limited library scares Netflix today. However, tomorrow may be a different story

As Netflix proved last week, it only takes one deal to change the entire outlook. Likewise Amazon has an existing ecosystem that Netflix would kill for. And it is not unrealistic to think that at some point Amazon will be able to leverage its Kindle Fire tablet as well as offering product promotions and discounts to entice loyal shoppers to become movie enthusiasts.

In the meantime, for Netflix, that is has started dabbling into original content sets itself apart from Amazon and even Apple whose iTunes is also considered a threat. Netflix seems to want to shape itself in the mold of HBO, Showtime and Starz. If Netflix can score a hit like The Sopranos or Homeland, there is no way that rivals like Amazon or even Apple can compete.

In that regard, Apple is already hurt by the fact that consumers insist that its a la carte model is expensive. Worse yet, Apple does not have the breadth of content that Netflix enjoys – at least not presently. But then again, Apple would only need an exclusive content deal to disrupt both Netflix and Amazon’s lead.

This is where a company like Time Warner (NYSE: TWX) might step in since it already has an agreement with Apple to distribute content to the iPad. What’s more, Time Warner, which owns HBO has every incentive to want to see Netflix fail. On the other hand, this has been a wish of cable companies for quite some time. To their dismay, Netflix refuses to die. It’s come close, but as with a scary flick, it’s come back in the sequel.

Bottom Line

As you can see, there are a lot of moving parts here. So depending on how you look at it, Netflix’s aggressive expansion in international markets as well as its original content can either be a huge hit or a complete flop. It all depends on how the competition responds. The good news is that the streaming market is not even close to being saturated – even with so many entrants.

For now, Netflix’s current lead is significant enough to the extent that the company can afford to sacrifice short term profits for a bigger future payday. Although the “if you build it they will come” model is always a risky bet, Netflix’s growth trend will continue to support the growth of the stock – at least for now.

In the meantime, before I’m willing to call the stock a buy, I want to first see where the net income figure is at the end of its next quarter. While I appreciate investing for the future as much as the next person, but a 90% profit drop in two consecutive quarters will require more than a snickers bar and a large bag of popcorn, because the stock may not be going anywhere for a while.


rsaintvilus is long AAPL and has no positions in any of the stocks mentioned above. The Motley Fool owns shares of Apple, Amazon.com, Walt Disney, and Netflix. Motley Fool newsletter services recommend Apple, Amazon.com, Walt Disney, 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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