An IPO That May Hurt Netflix

After a long dance -- perhaps it was swatting away prospective underwriters and potential suitors -- GameFly is ready to strike out on its own.

The specialist in video game rentals by mail filed to go public yesterday. The S-1 filing provides a healthy glimpse into a company that die-hard gamers admire but knew little about.

Well, we can now begin to fill in the blanks:

  • GameFly is growing quickly, yet still had only 334,000 subscribers as of the end of September.
  • The Netflix (Nasdaq: NFLX  ) of video game rentals has been profitable for more than two years.

Meet the anti-Netflix
Perhaps the biggest surprise in combing through the filing is that GameFly and Netflix may be renters of disc-based rentals by mail through a network of regional distribution centers, but their approaches to the game are completely different.

Let's start with sales. Netflix began offering excess DVD inventory to subscribers for as little as $5.99 a disc four years ago. If Blockbuster (NYSE: BBI  ) and smaller real-world rivals mark down previously viewed flicks for sale, why not Netflix? Wholesalers don't pay much for tired discs anyway, and subscribers can always warm up to bargains on their favorites.

Netflix axed the program two years later, arguing that it wanted to focus exclusively on the DVD rental and streaming businesses.

GameFly isn't shy about pitching its inventory to subscribers. Every rental has a "Keep" feature, encouraging renters to purchase the title they're working on. GameFly even began selling brand new titles through its site three months ago.

Another area where Netflix and GameFly are miles apart is in website monetization. Netflix has experimented with ads on mailers and on its website, but has gone on to discontinue the practices.

GameFly is more of a sponsored exhibitionist. It has gone on to launch or acquire game-related content sites and community hubs. It has no problem slapping ads all over,, and

It's a strategic portfolio for GameFly, because its sites command 4.4 million unique monthly visitors. Obviously, at least 4 million of them aren't current subscribers, so the company can shrewdly and cheaply reach out to die-hard gamers.

GameFly isn't alone in reaching out to Netflix's ideal audiences. (Nasdaq: AMZN  ) runs News Corp.'s (NYSE: NWS  ) IGN owns several gaming-related sites.

Netflix doesn't do this -- though perhaps it should.

The GameFly threat
"We're focused on being a movie and TV show company -- entertainment video," CEO Reed Hastings told me 10 months ago, after I asked him yet again why Netflix isn't offering game rentals. "That's what our brand is about. We're not focused on games either on the physical rental or on the electronic distribution."

He may be right, but why is it that more than a million Xbox owners were streaming Netflix through their consoles just a few weeks after it became available through Microsoft (Nasdaq: MSFT  ) ? Clearly there is plenty of overlap here. Excitement over Netflix's recent initiatives to stream through Sony (NYSE: SNE  ) and Nintendo boxes underscore the common ground.

How much bigger will Netflix let GameFly get before it responds? GameFly is growing quickly. It had just 74,000 subscribers at the end of fiscal 2005. It was up to 328,000 by the end of fiscal 2009.

I have yet to come across a sound argument for Netflix not entering the video game rentals business.

  • Games are more expensive? Yes, but GameFly charges $15.95 for its unlimited plan where gamers can have just one game out at a time. Netflix charges $8.99 for its similar DVD plan.
  • Games age quickly? Yes, there isn't much of a shelf life for some titles, but more than half of GameFly rentals are for titles that have been out longer than six months. Besides, unlike Netflix, GameFly is aggressive about moving its aging inventory through its membership base.
  • Die-hard gamers hold on to rentals for a long time? Well, that's a good thing. The average GameFly subscriber goes through 22 games a year -- or less than two a month. Netflix users go through roughly a half-dozen DVDs a month. Because round-trip mailing costs are a major model expense, infrequent shipments are good.

However, the real reason why GameFly's IPO is going to jab Netflix in the gut is that investors will now be able to compare growth trajectories. Through the first six months of fiscal 2010, GameFly revenue grew 21% as operating profits more than doubled. Netflix is no slouch, naturally, but there will come a time when investors begin to question why Netflix isn't a part of this high-growth niche.

It's the day that Netflix will begin feeling mortal, and likely kicking itself for not making a move in this space while GameFly was still in the crib.

Editor's note: Contrary to reporting in a previous version of this article,, a former IGN subsidiary, was  purchased by Flixster in January 2010. The Fool regrets the error. 

Microsoft is a Motley Fool Inside Value pick., Netflix, and Nintendo are Motley Fool Stock Advisor selections. Motley Fool Options has recommended a diagonal call position on Microsoft. Try any of our Foolish newsletter services free for 30 days.

Longtime Fool contributor Rick Munarriz has been a Netflix shareholder -- and subscriber -- since 2002. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 11, 2010, at 11:50 AM, caltex1nomad wrote:

    Netflix will wait and let Gamefly make all the mistakes. Netflix will sit back and wait, then at the right moment they will swoop in and buy Gamefly outright.

  • Report this Comment On February 11, 2010, at 12:27 PM, themaxpain wrote:

    Compared to Netflix, gamefly may well have advertising more figured out ... unfortunately they just don't seem to have the "service" part of their game rental service nailed down.

    Gamefly's queueing and shipping mechanics were terribly slow for me the three times I've tried to use their service. Despite being located in the same city as their nearest distro center (Austin) and 1-day-by-mail-away from another one (Pittsburgh) at another time, they regularly took weeks to ship even the 1st game of my allotted 2.

    I don't know when Netflix or anybody will try or try harder to compete in the mail-based game rental industry. If/when Netflix does, though, I'm fairly sure they will blow gamefly out of the water. All that said, it's an interesting IPO to look at, mostly given gamefly's ostensible monopoly on the service they currently (weakly) attempt to provide.

  • Report this Comment On February 11, 2010, at 12:31 PM, EskimoJoe74 wrote:

    Games are going to become almost 100% delivered digitally. Last time I bought a game from the store for my psp, it was an empty box with a redemption code on the inside to go to the Playstation store and download the game. If games are delivered digitally when purchased - this will undercut Gamefly's ability to rent and mail discs.

  • Report this Comment On February 11, 2010, at 7:41 PM, Daximus wrote:

    Xbox has an entire lineup of digital downloads of old Xbox 360 games. With the new 250gig harddrive Microsoft knows that digital downloads will be the next move cutting GameFly and GameStop in half. Besides, most gamers (myself included) will pay $60 for good games and pass on the crap...and there is a lot of crap right now.

  • Report this Comment On February 12, 2010, at 9:59 AM, ChannelDunlap wrote:

    I fail to see how Gamefly is a threat to Netflix in any way. They're entirely different industries, even if they are using the same model. I'm currently a Netflix subscriber, and if I owned a gaming console (PC4Life!) I'd be a Gamefly subscriber as well. There is plenty of room for both, but I like caltex's idea that Netflix could be looking at Gamefly as a potential acquisition somewhere down the road.

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