Investing In Netflix

Nick Kennedy

Twenty million. That’s the number of people who now subscribe to the DVD delivery service Netflix. The company beat analysts' expectations when it reported a fourth quarter profit of $47.1 million. With expectations hovering around 71 cents per share gain and earnings coming in at 87 cents, investors cheered and the television-and-film industry took notice. These are good days for movie buffs, who are now getting a wider range of content with a choice of viewing platforms (TV, laptop, iPad, etc.), but how should Netflix investors react? There’s reason for giddiness over the fourth quarter numbers, but there are some major obstacles to keeping this momentum going into 2011.
--The Move To Streaming Only--
You know how Netflix works. It sends you DVDs in those rectangular red envelopes, you watch them and then ship them back in a square white envelope. This model helped deliver a fatal beat down to Blockbuster and its obnoxious late fees.

Wary of becoming the next Blockbuster itself, Netflix stayed ahead of the game by announcing last year that it was going to offer a subscription that would deliver “streaming only” movies and TV shows. For $7.99 per month, you can watch over 20,000 titles instantly on your computer or TV. Clearly this will be the delivery option of choice for much film and television programming in the coming years. But can Netflix prove to investors that it will hold its own as a dominant player in this industry?
--What We Like About Netflix--
The fourth quarter numbers indicate that people responded positively to the company’s streaming-only strategy. Netflix added 3 million new subscribers in that quarter, and a full third of them signed up for the $7.99 “Watch Now” plan. New subscribers means revenue, and revenue means more cash to acquire more premium content (translation: good movies). Cash will also come via savings from the U.S. Postal Service for the shipping of DVDs. Those fees totaled $600 million in 2010.

But the future isn’t here yet, and don’t think Netflix is walking away from the DVD-in-your-mailbox service entirely. In fact, that service may get a boost if vanquished rival Blockbuster liquidates this year and its DVD delivery subscribers move over to Netflix.

Acquiring premium content has to be its primary focus if Netflix is going to do to future rivals what it did to the brick-and-mortar dinosaur that was Blockbuster. A new deal with Relativity Media, LLC promises to beef up the streaming content quality in 2011, which will include current Oscar nominee The Fighter in the early part of this year.
--What Concerns Us About Netflix?--
Netflix can’t possibly add subscribers at the rate it did in the fourth quarter of 2010. The number of subscribers increased 63% from the fourth quarter of the previous year and was more than a million new folks than was added in the third quarter.

The battle to acquire content hasn’t been smooth sailing, with the movie studios looking to maximize revenue the old-fashioned way by racking up big takes at the box office and then selling the DVDs before they’re available for rental on Netflix or Coinstar’s Redbox rental kiosks. This window -- the time between when the movie is released on DVD and when it is made available to Netflix -- stands at 28 days, and Warner Brothers, for one, wants to increase that.

The biggest concern: competition. Amazon is entering the streaming video business and is going to make some noise. It’s sitting on almost $9 billion in cash, while Netflix’s total market cap is $11 billion. Look for Amazon to use that money to acquire its own vault of premium content, including partnering with HBO (as Netflix has with Starz) to offer that network’s programming.

--The Bottom Line--
Don’t anticipate meteoric growth for Netflix in 2011. Eventually new subscriptions will level off, but it’s going to take a while for Amazon to present any kind of serious challenge. For the next 12 months or so, expect Netflix to continue to add value.