Why can’t I get my head around Netflix (NFLX) ??

By: ispeculatornew
Date posted: 03.02.2011 (5:00 am) | Write a Comment  (13 Comments)

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Take a look at the technology stocks that we follow and you will see very few big names missing in the internet space. However, some of those names have not often been picked in our tech stock picks despite being big names that should provide terrific trading opportunities. I can’t think of a better example of that than Netflix (NFLX), one of the tech giants which along with Priceline (PCLN) has been an incredible success story for many years now. How bad is it? To give you an idea, I have only taken Netflix twice in over 2 years of picks and have not gone either long or short on Netflix since last April, nearly one year ago.

It’s difficult to explain and while I have discussed Netflix a few times, I have been unable to get any kind of strong feeling about the company and its medium to long term prospects. It’s beyond frustrating to not be able to trade the name. In the past year, I have seen many trade Netflix and obviously those that went long generally came out in terrific shape. I have many great things to say about Netflix and would generally be bullish but I continue to see so much downside risk.

I thought I would do some kind of summary of my thoughts about Netflix in the hopes that I can gain some clarity but also that your comments can help give me some light. Believe me, I’d like nothing more than being able to add back Netflix as a solid candidate for upcoming 2011 trades. So let’s do this, a traditional “Pros” and “Cons” list.

Just before getting started, here are Netflix numbers as I usually analyze them when doing my picks:

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Pros:

-I think Netflix is a terrific property with key content agreements and an incredible distribution network. In fact, I had suggested twice that I believe Netflix would be a great acquisition for Apple.

If nothing major happens, Netflix seems poised to keep up sales growth of 20-40% for years to come… there is a big if however

-Any company that can take down a giant like Blockbuster in so little time has undeniable momentum

Competition is nothing new for Netflix and even players like Hulu which are backed by entertainment industry giants have been able to get anywhere close to slowing down Netflix

Content companies are left with little negotiating power as they need Netflix to gain access to the 20 million North American members that the company can offer

The stock has significant long interest making big name short sellers such as Whitney Tilson suffer as they close out losing short positions.

Cons:

-Netflix is in a unique situation where almost all of its partners have either already started or are seriously considering competing with it. Content providers have launched their own websites, devices, distribution networks and it’s unclear if partners such as Disney, Microsoft or Apple will end up being bigger competitors

A major alliance or a big move by Google through its Youtube property could significantly change the growth landscape. Amazon (AMZN) has also clearly announced it would be offering a competing product

-Netflix trades at such a high P/E ratio that even a slight decline in its growth rate could send the stock significantly lower

-I am worried about the huge content acquisition costs and how those will evolve over time and affect future profitability. As media continues to split and specialize, how many of these deals will Netflix need to make?

-It does seem like Netflix could be affected if some of the devices such as Apple’s Ipad/Ipod/Iphone or Microsoft’s XBox decided to start charging more for Netflix to use its platforms. It’s not clear to me who has the power here but it is a potential danger without any doubt.

Expectations remain so high for Netflix, how long can they keep the street surprised to the upside?

Conclusion

In the end, I do remain unconvinced although I would say that I tend more to be long Netflix (NFLX) at the moment, but would love to hear your thoughts on this name!

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13 Comments

  1. Comment by You know little — March 2, 2011 @ 10:46 am

    It’s also obvious you don’t know Netflix. Going by numbers alone and not knowing the business makes for a bad article. Have you seen the Amazon FREE videos? They are old movies that nobody would watch. Netflix plays CURRENT movies. There is a HUGE difference between 5000 free movies from Amazon if you are a Prime member vs the 50,000 or whatever that Netflix has.

  2. Comment by Chris — March 2, 2011 @ 12:21 pm

    I own a netflix account. And, I am not overwhelmed by their movie collection. The pace of their content acquisition is not very impressive either. Or atleast they do not show up in my watch instantly option, which by far I would consider is the best of Netflix offerings, and will gain more importance given the increasing number of mobile media, smartphones and smart TVs. I have been watching the stock since it was in 50’s. The price increase does not seem proportionate to the advances Netflix has made. Apart from Blockbuster going bankrupt which was anyways expected and a $1 subscription fee increase, there isn’t much that has happened. The content acquisition deals do not seem to have much impact on customer experience. I would consider Netflix is an expendable service for most customers. I am bearish about this stock at this price level. However, the main differentiator between Netflix and online other services is the lack of Ads. I am yet to find another online service of Netflix quality, that will not interrupt my viewing with Ads. Having TV Shows, good collections of Documentaries and Foreign Movies is an advantage. Also, Netflix app being part of Internet connectable TVs and Blu-Ray players is a great advantage. Consumers now look for Netflix / Youtube apps while buying a TV or a Blu-Ray player. Netflix app not being available for Android is a drawback.

  3. Comment by Navin — March 2, 2011 @ 5:16 pm

    There isn’t much that has happened since the stock was in the 50’s, Chris? the most important thing that had happened is that Netflix is available for instant streaming on every gaming console and a number of mobile devices. The TV content is top notch and the streaming price of 7.99 is exceptional.

    The major concern with Netflix, for me, is the cost of content acquisition. Netflix was able to garner favorable rates with content providers like Starz the first time around… But they are going to pay more this time around. They have deep pockets now. An acquisition by Aapl would send the stock jumping though…

  4. Comment by Andrew — March 2, 2011 @ 6:40 pm

    The reality is that Google, Amazon, Apple and other competitors are quickly entering this market, and this should scare you about being long, if not then you are disregarding the potential risks. Margins will be compressed when competitive offerings and newer content that will put Netflix’s antiquated library to shame. I would not be bearish right now because there are simply so many bulls behind this name that is a scary prospect to go short now. Once people realize the valuation is crazily streched, Netflix stock will get clubbed.

  5. Comment by Open source portfolio — March 2, 2011 @ 6:41 pm

    I agree with you 100%. Once the other providers like Amazon and Google settle their content, Netflix will have to really split the market with them or compete on price.

  6. Comment by IS — March 2, 2011 @ 9:08 pm

    @You Know Little – Dont think I mentioned anywhere that Amazon had current movies or anything like that… they have been working on a competing product and Amazon is too big to discount that easily in my opinion

    @Chris – Very good points thanks. And actually, Netflix and Android should be hooked up very shortly!

    @Navin – Good point about streaming, that has been a major game changer. So do you think content acquisition costs are increasing faster than revenues?

    @Andrew – One question that I have is if these companies will compete as much on prices (and thus margins) as on the depth and quality of their content. I guess through acquisition costs both would impact margins but it will be very interesting

    @Open source portfolio – I do however like where Netflix has been on pricing making it difficult for the competition to undercut them easily.

  7. Comment by DOGGIE — March 2, 2011 @ 11:01 pm

    They are cooking the books it is only a matter of time until the public finds out. My buddy is on board with them in the upper offices, he is actually shorting big time.

  8. Comment by Andrew — March 3, 2011 @ 1:20 am

    IS you are right, I looked the Netflix operating margin at 13% and profit margin at 7% which are slim even now for Netflix so it is not likely that they can be severely undercut in price by a competitor. However as others have mentioned, their content is not the new content consumers demand and they will certainly have to pay higher acquisition costs for newer media…

  9. Comment by IS — March 5, 2011 @ 5:53 am

    @Doggie – please give some specifics…difficult to work with such a broad statement:)

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