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Could This Stock Be Netflix'd?

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

If you are looking to back a stable media business, you naturally have to consider the competition. Are there free alternatives? More convenient alternatives for consumers? Could there be a secular shift? If, say, a major producer is about to replicate essentially your same product and promote it widely to their existing customers, you may have problem. I find that Netflix and Pandora in addition to rising competition face significant headwinds on the cost side of the equation...

Netflix (NASDAQ: NFLX) Vs. Coinstar (NASDAQ: OUTR)

Once upon a time there was a "Friends" page on Netflix where subscribers could communicate with fellow movie goers, recommend movies, and review their latest views. There was an attractive DVD package that came with free streaming and dedicated support. A few poor management decisions later and what could have amounted to potentially a powerful social network devolved into separate DVD and streaming segments. The actions resulted in an $11.2 billion destruction of shareholder value--more than double the current market cap. But with shares recovering 75.3% from the 52-week low, the question now turns to whether the bears overreacted.

With a short float of 28%, the bears don't look they are going away any time soon. Oppenheimer and Caris & Co. responded to the bull run by lowering their ratings from "outperform" to "perform" and "average" to "below average", respectively. The company's problems include rising media content costs and competition from cheap and even free alternatives. Amazon has already released its own streaming business that is cheaper than Netflix's plan. Further, Hulu and Coinstar's Redbox continues to grow in popularity. Redbox is basically a vending machine that distributes rentable DVDs for a cheap price (typically, $1.20)--usually movie releases. Further, Coinstar recently reached a JV agreement with Verizon that would created Redbox Instant, a subscription package to thousands of movies priced at $8 per month--the same price as Netflix's offerings. So what we have with Coinstar is a company that is offering convenient movie rentals through Redbox and unlimited streaming--a combination that Netflix does not have.

And though Netflix speaks favorably about its opportunities abroad, the company has yet to be profitable and sustainable. The Coinstar-Verizon partnership is just not the news Netflix bulls need during this challenging turnaround period. The cheapest plan that Netflix offers in streaming plus DVDs is $16 per month. If Coinstar can give Instant consumers special deals on DVDs, it could easily drive Netflix customers away.

Netflix:Coinstar | Pandora (NYSE: P):?

Pandora may just be the next company to be Netflix'd. The internet radio company has rightfully slid 36% from the 52-week high, but analysts are now moving towards a "buy" recommendation. On December 5, Stifel Nicolaus gave the firm a $14 price target, which is a 63% premium to the current market assessment. But even by the Street's own estimates, it will take a while to get to profitability. Pandora is expected to lose $0.15 per share in fiscal 2013. And the growth story is starting to wane with Spotify putting the final nails into the coffin.

In particular, it is struggling from ever-rising royalty costs. The company essentially pays a royalty free every time a song is streamed onto a desktop or smartphone. Revenue growth has decelerated more than content cost growth, which means margins are going down. Sirius is able to get content costs at a much cheaper price, so Pandora is busy trying to get Congress to pass the Internet Radio Fairness Act. Apple is currently negotiating with recording labels to produce a streaming radio platform very much similar to Pandora's but only under a wider market to promote to and potentially much cheaper royalty terms. Needless to say, Pandora does not have the resources to compete effectively against the world's largest public company. Put differently, Pandora may end up being Netflix'd by Apple.


TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Netflix. Motley Fool newsletter services recommend 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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