Can Netflix stay afloat?

As with RIM, the media company is starting to feel the pressure that comes with being a market leader.

By TheStreet Staff Jul 16, 2012 11:07AM

By Richard Saintvilus

 

Warren Buffett once said, "The key to investing is not assessing how much an industry is going to affect society, or how much it will grow but, rather, determining the competitive advantage of any given company and how long it can maintain that advantage.

 

In other words, Buffett believes in investing in monopolies. While these are hard to come by, there are some companies, such as Sirius XM (XM), the only satellite radio company in the U.S., that come pretty darn close.

 

However, in situations where there are no monopolies to be found, investors can always rely on some key ingredients of a successful company. Not necessarily in this order, these components include innovation, strategic marketing, staying ahead of the competition and managing costs.

 

Oh, and there's the most important factor of all -- getting as much money as you possibly can out of the customers you have.

 

There are some companies that do some of these well and there are others, such as Apple (AAPL), that excel.

 

However, what do you do when you come to a point and realize that a company in which you have invested has ceased to excel at any of these five components, maybe not entirely but enough that it has become noticeable?

 
The Effective Delivery

This is where streaming media giant Netflix (NFLX) finds itself.

 

In an odd sort of way, the company is both a titan and an underdog at the same time, which makes it a challenge in determining how to root for it. Netflix reminds me a lot of Research in Motion (RIMM), except with better management.

 

While RIM essentially took Palm by the hand and escorted it out of business, Netflix took a more distant approach and wiped out Blockbuster with a postage stamp and its red envelopes. The company pioneered an industry that is now changing.

 

Netflix was able to impose its will and capture the imagination of movie lovers everywhere to the point where it became an embarrassment to be seen Friday nights at your local Blockbuster or Movie Gallery. It was successful in changing the game by creating a "room service industry" for movies.

 

It was just a matter of time before people started questioning their own logic of not using it. It no longer made sense to drive to a Blockbuster, stand in line, search through its entire collection, and then have to deal with late fees. Blockbuster, the once-hot spot for Friday nights, became old overnight. Netflix took over the market -- both the movie industry and Wall Street.

 
The Empires Strike Back
However, with such exceptional growth, comes a lot of attention. Netflix started to get a lot of it not only from Amazon (AMZN), which recently launched a competing service called Prime.

Also, members of the cable industry started to wonder about their own futures -- namely Time Warner (TWX) and Comcast (CMCSA).

 

The first evidence of this concern came when Time Warner's HBO unveiled its now-widely popular HBOGo Internet streaming service. Subscribers of HBO are now able to access all of its on-demand content online, free of charge. Though HBO says it has not plans of making this service available to non-subscribers, its ease of use as well as interface is arguably equal to or better than Netflix's.

 

Also showing some concern was Comcast. In February, the cable giant announced its plans to go toe-to-toe with Netflix with its own Internet movie streaming service called Xfinity Streampix, one that will offer a library of TV shows and movies.

 

As with HBO, the service will be made available only to its current subscribers. However, the difference is that unlike HBO, under programming agreements, Streampix can also operate as a standalone service outside of the cable subscription package.

 

As with RIM, Netflix is started to feel the pressure that comes with being a market leader.

 
The Netflix Channel
However, unlike RIM, it seems Netflix is willing to make the necessary adjustments. Where it can be argued RIM dominated the enterprise at the expense of sacrificing the wants and needs of consumers -- which ultimately led to Apple's dominance -- Netflix is demonstrating that it will leave no stone unturned to maintain its market share, even if it means sharing (literally).

 

In a stunning move, Netflix CEO Reed Hastings has decided to "think inside the box." The company has had discussions with some of the largest cable operators and appears to want the company to have its own channel on their cable offerings. The idea is that Netflix would become available as another on-demand option for cable subscribers through their set-top boxes.

 

Netflix essentially wants to pay cable companies just for the opportunity to compete with their own premium movie channels including Showtime, Starz and HBO. If this works, the cable companies would receive a subsidy for offering Netflix as an additional option added to a customer's cable bill.

 

So, for as much criticism that Hastings have received recently, I think it is only fair he receives a considerable amount of credit for even considering this.

 

The question is, will it work? I ask because upon the release of its first-quarter earnings report, the stock dropped 14%, the biggest decline since October. Though it has since rebounded modestly, there are yet some concerns about its ability to survive.

 

What continues to bother Netflix investors is the company's inability to sustain growth. During the announcement Netflix warned the subscriber total would drop in this current quarter, and as a result has started to shift its focus towards making money instead of growing subscribers. It has essentially admitted that subscriber growth has (for all intents and purposes) stopped.

 

While that may be cause for concern, it means the company is now prepared to start generating real value from the subscribers it currently has. In other words, even through its warning there was cause for optimism in that it now plans to focus on what really matters: earnings per share.

 
Bottom Line
While Netflix has some similarities with RIM, I don't think anyone can say that its management has been sleeping at the wheel.

 

As much as I enjoy the service as a loyal subscriber, it is still hard for me to consider that Netflix will be able to survive the onslaught that is certain to come from Amazon's Prime service as well as Apple and Google (GOOG), which have their own TV plans in place.

 

The question is, what would be left for Netflix outside of an acquisition if larger rivals start eating away at its margins? How much would it take to make a deal happen? With Netflix currently trading at $84 -- down from $300 one year ago -- would Reed Hastings and the board accept an offer from any suitor of less than $150 per share?

 

All of this notwithstanding, it goes back to Buffett's comment about being a successful investor. In this case, Netflix lacks the competitive advantage to make it through the long term. So, accordingly, though its streaming service comes highly recommended, the stock does not.

 

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13Comments
Jul 16, 2012 2:56PM
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I have been a loyal patron of NetFlix for several years now and they do seem to have their act together. The streaming has come a long way to present great HD video presentations. That being said, they are beginning to pizz me off when it comes to the dvd offerings. Even though I am aware of the reasons why, it sucks when some of the new releases are not available for up to six weeks when I can get most of them at RedBox, DVD or Blue ray, much sooner and at almost the same price. I am probably going to drop the mail selections and keep the streaming service, at least until something else better comes along. The other streaming services do not offer a lot of the selections that I prefer such as a lot of the quirky British TV shows offered by NetFlix. But for now I will remain as a member and give them a chance. 
Jul 16, 2012 3:54PM
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They ticked off so many consumers with their split of services, basically doubling their prices.  I use Redbox now.  There are 4 close to my house.  Since I have a Kindle I may add Amazon Prime.  Netflix got too greedy and ruined a good thing by doubling their prices instead of a small hike.  I wouldn't invest any money in Netflixs.
Jul 16, 2012 3:14PM
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Time for the monthly Neflix doom article.
Jul 16, 2012 4:13PM
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Netflix's main problem is content.  Its movie choices declined dramatically with the loss of STARZ and now it is not adding hardly any of the more popular newer movies.  I still have the streaming service, but don't know how long I will keep it because I am not using it very much.  Now if I want a good movie I usually just go rent one.
Jul 16, 2012 3:03PM
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I had a Netflix account for a little over two years.  My request for two movies sat in the wait/back-order box the whole time.  There were other movies that I requested that the wait was shorter; but, to try and obtain information on requested movies I needed to call a toll-free number, wait for a human to finally take my call, then hear "As soon as possible".  
I switched to Hulu when Netflix raised their prices and have had to problems.
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They will never get my business back, why reward someone for greed (massive price increase).
Jul 16, 2012 3:42PM
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Netflix streaming service is terrible.  Most of the movies are older.  Blockbuster allows you to stream newly released movies.  I don't consider Netflix the industry leader.  Blockbuster must ramp up its marketing.
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Netflix doesn't offer much in recent releases of real movies, not streaming. What's up with all the Japanese films? I will probably cancel again if they don't improve their streaming content.
Jul 16, 2012 5:51PM
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I dont know when this big price hike took place, so I won't pretend to but netflix prices do not bother me.  I never did the DVD mail thing but I have netflix, hulu and regularly use redbox; this is in place of regular cable/satellite that I find absolutely worthless except for maybe a handful of channels.  I prefer netflix simply because there are no commercials.  Again, NO COMMERCIALS!!! 

That means never having to see the same stupid tide advertisement 14 times in an hour long episode.  Hulu is every bit as expensive as netflix, yet you see the same amount of advertising as a cable TV channel.  I am assuming that people crying about price don't use hulu at all or, I would guess, loves commercials and does not use braincells when making an objective comparison.  My biggest problem with netflix is the outdated TV and movies (which hulu is handy for) but seriously, for $10 a month you can watch unlimited TV and movies without COMMERCIALS, nobody but a major cheap **** is going to complain about that. 

Jul 16, 2012 3:59PM
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Netflix lost customers last year when it split streaming video from DVD delivery, but is slowly gaining market share and watching its stock price regain steam.  Whether Netflix remains a viable contender as new means of sharing media emerges remains to be seen.  If Netflix took down Blockbuster and Movie Gallery, a new player could likely do the same to Netflix.  Redbox is a viable alternative, and is available everywhere, making it convenient.  The future is still foggy about who the winner in the streaming wars will be, though.
Jul 16, 2012 9:07PM
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I love Netflix. There's ALWAYS something good on streaming and NO COMMERCIALS. I dumped my Comcast acct about a year ago and I am so happy I did! I can't believe I was paying SO MUCH for cable month after month and still having to watch commercial after commercial. Life is too short. I love Netflix; both DVD and streaming. Totally awesome.
Jul 16, 2012 7:00PM
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I am going to close my netflix account.  Not many movies, same old thing all the time.  They wont miss me

Jul 16, 2012 6:56PM
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Just going to a EU site and seeing TODAY**** Today...is just fine for me...even if he can't hold a camera correctly oy Some Big head getting up to pee or drank. Yep

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