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Is Netflix About to Drive Away Millions of Subscribers?

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

It’s barely been two years since the Qwikster debacle, but Netflix (NASDAQ: NFLX) might be in the process of making another terrible decision. As of May 1, Netflix subscribers could find that some of their favorite titles are no longer available for streaming.

By allowing various content deals to expire, Netflix has lost the rights to stream nearly 1,800 different titles -- and more could be on the way. Netflix CEO Reed Hastings has made it clear that the company wants to move in a different direction.

While that might prove to be the best decision for the company’s long-term future, in the short run, Netflix could end up driving many subscribers away.

Netflix is reinventing itself

Alongside its earnings report in April, Netflix released a letter discussing the company’s strategic vision for the future. (The entire letter can be read here -- all investors interested in the company should read it in full.)

Simply put, Netflix wants to change its streaming service. Gone are the days when the company was willing to accept any deal to bolster its available titles -- now, Netflix is only interested in exclusive content.

Netflix’s streaming service has long been criticized as nothing more than a hodgepodge of low-quality, old movies combined with a few TV shows. While that may be a fair characterization of what Netflix offers, that hasn’t stopped the company from amassing a domestic subscriber base of nearly 30 million.

But for what Netflix is planning, 30 million isn’t nearly enough. Hastings believes Netflix can reach 90 million subscribers, and given the amount of money the company has pledged to pay content providers in the future, 90 million may be necessary to make Netflix’s business work.

An Internet HBO

To put it bluntly, Netflix wants to become Time Warner’s (NYSE: TWX) HBO -- an HBO that you get through the Internet, not your cable provider. That certainly isn't a bad business model to replicate, but the transformation could cause some growing pains.

HBO does a few things unbelievably well -- when it comes to original shows, no other network compares. Series like The Sopranos, The Wire, and Game of Thrones keep the network’s subscribers loyal -- all of whom willingly dish out $10-$20 per month on top of an already expensive cable bill.

As an HBO subscriber myself, I think it’s a great deal for the money. But at the same time, I understand that HBO isn't really an alternative to Netflix.

HBO’s content is great, but it’s limited. HBO produces around 10 original shows per year, and rotates its perhaps two dozen Hollywood movies on a monthly basis. Contrast that with Netflix -- it offers literally thousands of movies and TV shows.

In short, while both are a form of entertainment, they satisfy different needs. HBO is a supplement to a cable package; Netflix is a potential alternative.

The Qwikster debacle destroyed shares

At the start of 2010, shares of Netflix were trading near $50. By the summer of 2011, they had reached $300. During the run, a number of investors (such as Whitney Tilson) publicly doubted the stock’s prospects, arguing that shares had run up too aggressively and were poised to fall.

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That prediction ultimately came to fruition -- by the end of 2011, shares had collapsed by over 80%! What prompted the bursting of that Netflix mini bubble? A boneheaded decision by the company’s management.

In September 2011, Netflix announced that it would split its business in two -- Netflix for Internet streaming, Qwikster for DVDs by mail. Those subscribers who wanted both would now be forced to use two different websites and pay two different $8 per month fees -- what amounted to a big headache and a 60% price increase.

After experiencing a tremendous public backlash, the company backed off somewhat (ditching Qwikster, yet keeping the price increase) -- but only after it had lost almost a million subscribers in the process.

Alternatives to Netflix?

To be fair, most of what Netflix lost in May was a bunch of old movies; the sort of content many subscribers likely won’t miss. But given what Netflix has said, it might just be the beginning.

In June, the company’s deal with Viacom will expire -- that will mean a loss of many MTV and Nickelodeon shows. Netflix has said it is willing to reacquire this content through new deals, but only on an exclusive basis. Likely because Netflix is aiming to differentiate its service from its competitors.

Although Netflix has gained many competitors in recent years, Amazon (NASDAQ: AMZN) Prime Instant Video is the most formidable. A Prime subscriber must pay up front, but over the full year, the cost of Prime is less than Netflix. In addition, Prime subscribers get access to other Amazon services -- free two-day shipping and the Kindle lending library.

And while Netflix may still have more content than Amazon Prime, there is a significant crossover. Amazon Prime, for example, has a similar deal with Viacom.

Letting its content deals lapse may benefit Amazon Prime in the short term, as the difference between the size of their content libraries recedes.

Setting up for a repeat?

Netflix shares have rallied rapidly in just the last several months. Since the beginning of last October, shares of Netflix have more than quadrupled.

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That rally has largely been predicted on two solid earnings reports -- reports that had the company beating earnings expectations while reaching nearly 30 million domestic subscribers.

If Netflix’s willingness to let content deals lapse is enough to provoke a similar exodus of subscribers, shares could be setting themselves up for a repeat of 2011.

The tumultuous performance of Netflix shares since the summer of 2011 has caused headaches for many devoted shareholders. While the company's first-mover status is often viewed as a competitive advantage, the opportunities in streaming media have brought some new, deep-pocketed rivals looking for their piece of a growing pie. Can Netflix fend off this burgeoning competition, and will its international growth aspirations really pay off? These are must-know issues for investors, which is why The Motley Fool has released a premium report on Netflix. Inside, you'll learn about the key opportunities and risks facing the company, as well as reasons to buy or sell the stock. The report includes a full year of updates to cover critical new developments, so make sure to click here and claim a copy today.

Joe Kurtz has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Netflix. The Motley Fool owns shares of Amazon.com 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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