Don't Let Netflix Fool You; Buy This Stock Instead

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

With the proliferation of cheap to free online media options, traditional broadcasters and content producers have struggled to keep margins up. However, the wave of smartphone and tablets has created a major opportunity in terms of distribution. Several competitors have made moves onto this secular transition, so it's important to gauge the level of sustainability. Below, I review two companies with varying risk/reward.

Don't Jump On the Netflix (NASDAQ: NFLX) Bandwagon

Simply put, Netflix's 58% rise over the last three months is unwarranted. While successful investors like Carl Icahn and Whitney Tilson have disclosed major stakes in the media provider, the long term does not look pretty. Analysts have been even jumping on board the Netflix bandwagon after a deal was signed with Disney (NYSE: DIS). Here's why you should still avoid the stock:

The major part of the Disney deal -- access to new theatrical titles seven months after release on several medium -- won't begin until 2016. There are many moving pieces in the fiercely competitive landscape that Netflix occupies and, accordingly, there are also many opportunities for Netflix to release the next "Qwikster" move. With upwards of $300 million in royalties to be paid to Disney annually for the deal, Netflix can -- and, in my view, probably will -- be in for a financial spin come 2016. In the third quarter, management reported a ~350% y-o-y rise in international expenses. Netflix may have to raise expensive capital to get the exclusive titles under such an downward environment: as the company expands abroad, its margins have declined.

And we should expect margins to erode even more from the general competition. There's Amazon (NASDAQ: AMZN) Instant, Hulu, Coinstar's Redbox, and America Movil. The last of these is rolling out basically the same thing as Netflix, but at a 33% discount in Mexico. Apple has also been speculated as a major contender, but I see more of a threat coming from Coinstar (NASDAQ: OUTR), which just a little time ago announced it was partnering with Verizon and rolling out instant streaming services in a limited number of markets on an invitation-only basis. Coinstar also owns the Redbox concept, which is a vending machine that distributes videos --often titles that have just arrived from the movie theaters a few weeks earlier. There is tremendous workable synergy here.

Meanwhile, Amazon Prime Instant has signed a deal for thousands of TV episodes and new film titles. In a November ChangeWave study of online video users, 82% of respondents said they use Netflix (down 200 basis points since February) while 22% said they use Amazon (up 500 bps since February). And since June 2011, usage for the latter is up 1,400 bps. The competition from Amazon has become such a concern that even the CEO of Netflix had to voice it. And although 27 million subscribers may have signed onto Netflix, Hulu is not far behind with 3 million paid subscribers and no telling how many free users. It has seen sales jump 65% y-o-y.

According to Netflix, Carl Icahn is "very supportive" of current management. The billionaire activist investor has made a name off of getting beleaguered companies to reform corporate governance practices and create shareholder value in the process. Netflix was a prime target for its series of managerial missteps and perception of managerial abuse on the part of the CEO. If Icahn is not willing to step in and shake the company, I see little positive catalyst from here.

Bull Run Won't End For CBS (NYSE: CBS)… Here's Why:

For a much, much safer media investment, I recommend going with CBS. Whereas Netflix trades at 7.1x book value, CBS trades at only 2.3x book value. In mid-November, Barrington Research came out with an "outperform" rating and a $48 price target, or a 28.8% premium to the prevailing price. While I think the company is an encouraging growth play, I do not find it undervalued. Bear in mind that CBS has already experienced a bit of a bull run with the stock up 47.3% from the 52-week low and around an all-time high.

Assuming CBS meets expectations, 2016 EPS will come out to $4.22. At a multiple of 15x, this translates to a future stock value of $63.30. This provides for an average annual return of 15.3% when you factor in dividend distributions -- easily worth an active investment. Discounting backwards by 10% yields a present value that is roughly in-line with the current market assessment. The company also has more than double the volatility of the market. So, while there is not much of a margin of safety, growth prospects are strong.

Primetime rating of same-day and live viewing has fallen more than 10% for 18-49 year olds. Even though CBS's ratings have fallen ~25% leading up to October, the ratings are still the top or near the top. This "market leader" status is really the most important factor, since it will result in the company receiving premium ad rates. TV viewership, in general, has been on the decline due to competition coming from online alternatives. However, CBS has largely addressed this concern through signing a deal with Hulu to release CBS content to Hulu Plus subscribers starting next year, among other strategies. Moroever, the company expects to generate north of $1 billion in reverse compensation and retransmission fees from its TV shows by 2017 anyway, as the content moves onto a broader cable platform.

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