What Will It Take to Kill Netflix?

Movie rental maven Netflix (Nasdaq: NFLX  ) has absolutely destroyed the market lately. The stock price has gained more than 150% over the last year, and that meteoric rise has brought critics out of the woodwork. Convinced that this golden age can't last, short-sellers have piled on and now hold more than 25% of the float.

In other words, a lot of people are betting a lot of money on Netflix falling back to earth, preferably to a fiery death.

But what will it really take to kill Netflix -- and how likely are these doomsday scenarios? Let's find out.

Threat No. 1: It's nothing special!
So Netflix is shifting from a rather unique DVD-by-mail operating model into an all-digital download service. To many critics, this is tantamount to filling your business moat with concrete and installing a paved six-lane highway right across it. Digital media is easy, right? Surely somebody else will figure out how to do it better!

Well, it's actually not trivial to beat Netflix at this game (and don't call me Shirley). The company has a serious head start in both technology and Hollywood relations, having worked on both for a decade or more. If you thought that a company named Netflix would be satisfied with mailing red envelopes until the format became a quaint anachronism, you're sadly mistaken.

Hulu and YouTube may seem like serious contenders, but neither one touches the Netflix core market of back-catalog feature films. Apple (Nasdaq: AAPL  ) , Blockbuster, and Amazon.com (Nasdaq: AMZN  ) do face off against Netflix in that field, but all of them lean on per-rental fees and time-consuming downloads. Netflix is the king of subscription services and instant gratification. The Blockbuster Total Access plan does not include digital movies, though it remains the only true competition to the traditional DVD-by-mail side of Netflix.

All of these potential rivals would need to redefine their business models in order to even step on Netflix's toes. Even then, they're a long way from posing a real threat to a service with more than 15 million sticky subscribers.

Threat No. 2: Movies on demand
I will agree that cable giants such as Time Warner Cable (NYSE: TWC  ) and Comcast (Nasdaq: CMCSA  ) hold a potent weapon in their on-demand technologies. Click a button on your remote, and you get a movie -- often a recent hit and sometimes one that's not even available to buy on DVD yet. The 30-day delay on new DVD releases for Netflix is one thing, but the streaming catalog rarely touches anything made in the past few years.

And again, these are two ships passing in the night. The cable guys have a lock on new releases but can't compete with the depth of the Netflix library. This divergence will only grow in the coming years as Netflix sits down with Sony, Time Warner (NYSE: TWX  ) , and the other big studios to hammer out increasingly favorable digital licensing deals. Meanwhile, it seems easy enough to add tons of content to those on-demand menus, but nobody is going there. Shouldn't the cable industry appreciate the value of the long tail more than most?

So here's a real threat but one that's unlikely to go anywhere. The high-margin on-demand model of today is too delicious to trade in for cheap or free back-catalog movies. Netflix goes free again.

Threat No. 3: Redbox
OK, Coinstar (Nasdaq: CSTR  ) has a hit on its hands with those ubiquitous Redbox rental machines. But if you've paid attention this far, you should see why Redbox doesn't have Netflix shaking in its boots: You're comparing apples to duckbilled platypuses.

The Redbox model aims right for the heart of Blockbuster's rental stores, skirts around the on-demand cable offering, and touches on the fresh-stuff-now libraries of Apple and Amazon. But it's not a digital service, and I don't see a product like that coming up. Redbox does a small assortment of new releases while Netflix goes deep and wide in movie history. Simply put, they're entirely different beasts with target demographics that may overlap to some degree but are largely complementary.

Call me when Redbox goes online. No, scratch that -- call me when it goes online with a subscription model. Otherwise, it's just competing more with Apple and Amazon.

So what does it take, then?
Of course, Netflix is not bulletproof, and there must be some Kryptonite around here somewhere. Here's how I can see Netflix going down in the foreseeable future:

  • Comcast throws caution to the wind and goes all-in with on-demand services. This won't happen because its legion of content providers would fight this move every step of the way, and the company hardly wants to antagonize all of it partners, suppliers, and customers at once.
  • Apple abandons the per-rental model and sells subscription services through iTunes instead. This isn't likely because all of its digital licenses would have to be renegotiated (see Comcast, above), and Apple would get sucked into a lower-margin layer of the movie market. That's just not how Steve Jobs operates.
  • Hulu and its backing consortium of Hollywood giants look beyond the TV episode market and make a grab for full-length movie domination. This is perhaps the most likely of all the threats, but Hulu still faces an uphill battle against 15 million paying Netflix subscribers and clashing agendas behind the hands that pull Hulu's strings.

The bottom line
Netflix is not cheap right now, but sometimes you get exactly what you pay for. There are lots of potential threats on the horizon, but no credible ones within striking distance. The stock could pull back a bit every now and then, but the long-term value of Netflix is nearly indisputable. And unless one or more of these rather unlikely downfall scenarios comes to pass, short-sellers will be left holding a very expensive bag.

Did I miss your favorite Rube Goldberg machine of Netflix destruction? Enlighten us all in the comments below.

Fool contributor Anders Bylund is well aware of the backward symbolism of a "meteoric rise," thank you very much. He (grudgingly) holds no position in any of the companies discussed here. Apple, Amazon.com, and Netflix are Motley Fool Stock Advisor recommendations. Try any of our Foolish newsletters today, free for 30 days. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


Read/Post Comments (34) | Recommend This Article (30)

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 August 06, 2010, at 3:03 PM, bottomgremlin wrote:

    Netflix also has a jump on everyone else with supported TV-connected devices. Wii, Xbox, dvd-players and even TV-s, almost none of the competitors come close.

  • Report this Comment On August 06, 2010, at 4:08 PM, verylargelarry wrote:

    Could not agree more with this article, save one point...

    The insinuation is that shorts have been piling onto NFLX recently. In fact, the 25% short ratio is the lowest in several years. As long as I can remember (I've held NFLX for 4 years now) that ratio has been above 30%.

    Makes me very happy.

  • Report this Comment On August 06, 2010, at 4:13 PM, verylargelarry wrote:

    To Jennifer, above...

    Netflix TV? Really?

    Where, pray tell, do you get your content???

    Hulu (and others) has offered network based TV for free for some time now. Streamed to your TV for several years, at least. What new benefit does seetvpc.com offer?

  • Report this Comment On August 06, 2010, at 4:54 PM, verylargelarry wrote:

    JenniferWeb...

    Checked out your sites. And they are interesting to say the least. I will be moving soon, had already planned to cut out the cable bill for TV, and your tips will help. Thanks!

    Cannot agree with your conclusion that NFLX is toast. Both your sites allude to subscription costs (nothin' is free, after all). And the content is different than NFLX, which has captured a huge number of movie nuts. TV is a side dish for these nuts, not the main course. I'm thinkin' these sites have it the other way. Its like the apples to platypus analogy in the article....

    Your complement noted...and appreciated. Giggle.

  • Report this Comment On August 06, 2010, at 5:15 PM, FoxValley2012 wrote:

    I'll check out seetvpc.com as well. I am a big Netflix fan. For $9 bucks a month, I feel I get more than my money's worth.

    If seetvpc.com can be played on my HDTV with the same qaulity picture and sound as Netflix (HD streaming content is increasing), then there might be some competition. But seetvpc.com seems to be going after cable TV.

  • Report this Comment On August 06, 2010, at 5:37 PM, Popnfresh100 wrote:

    I've had a Netflix subscription for years, but I ran through my "queu" a long time ago and now I'm paying $15 a month for nothing.

    I didn't realize redbox, Apple and Amazon carried new releases first. I guess I can finally cancel my subscription. Thanks for saving me the $$$.

  • Report this Comment On August 06, 2010, at 5:54 PM, mattack2 wrote:

    Those sites mention have GOT to be a scam. Especially the ones with one time fee. They've got to be at the very least copyright infringement.

  • Report this Comment On August 06, 2010, at 6:10 PM, BioBat wrote:

    Jenniferweb has been posting that spam on other sites as well, so take her advice with a grain of salt. seetvpc and the other site are not entirely legal, in fact, I'd be willing to bet that they're entirely illegal because they seem to be rebroadcasting OTA signals through the web without a broadcast license. On top of that, there is a lot of internet discussion on people ordering these services and getting nothing (you can only order through paypal). This one's got buyer beware written all over it. Not a threat.

    Popnfresh - Redbox does not have new releases, they have the same 28 day delay on new releases that Netflix does. Apple and Amazon, I can't comment on in terms of new releases but I can comment that if you're watching more than 1 movie a month, you're better to go with the 8.99 option from Netflix.

  • Report this Comment On August 06, 2010, at 6:35 PM, verylargelarry wrote:

    My other thought for Popnfresh....if you've already watched all the movies you want, you're watching too many movies.......

  • Report this Comment On August 06, 2010, at 6:35 PM, rookie2009 wrote:

    If CNBC ever has a comedy show, you could at least be a writer. 6 lane highway on a concrete moat....Priceless! What's in your wallet? Realistically, I thought Netflix was pricey in Feb 09. That's one reason my name is rookie2009.How about something about HP, and their "great leader" Mr. Anders.

  • Report this Comment On August 06, 2010, at 9:02 PM, Grandepiacere wrote:

    I dumped Comcast a while ago, put up a digital antenna and pay my $9 a month to Netflix with no remorse. Unless you JUST have to have all the newest releases Netflix kills the competition for choice. Even my TV junkie wife loves it as she blows through an entire past seasons shows in two days. Anyone who uses up the Netflix content will run out of new cable content to watch even faster. Netflix keeps adding and adding. The one area I see where Netflix cannot deliver is sports. Ohhhhh nooo.

  • Report this Comment On August 06, 2010, at 9:04 PM, Grandepiacere wrote:

    PS I do have one regret about Netflix. I should have bought more!

  • Report this Comment On August 06, 2010, at 9:23 PM, BioBat wrote:

    Netflix doesn't deliver on sports but honestly, you can get all the sports you want through subscriptions to MLB TV (also streams through internet enabled TV devices) and similar services by the other leagues AND subscribe to Netflix for less than a year of cable will cost you. I said it before and I'll say it again, people are completely wrong looking at Netflix as a DVD rental service because they're not. They're a CONTENT DELIVERY service and nobody has anything that remotely comes close to doing what they do.

  • Report this Comment On August 06, 2010, at 10:06 PM, lowmaple wrote:

    are there some shorts writing in?

  • Report this Comment On August 06, 2010, at 10:49 PM, MikeW92103 wrote:

    Another threat: Net neutrality goes down to defeat, leaving internet service providers free to "manage" traffic on their networks as they see fit. Since most of them are also in the business of selling TV programming, they see fit to block, slow, and impair traffic from the Netflix streaming servers, since it competes with the TV products and services they want to sell.

  • Report this Comment On August 06, 2010, at 11:15 PM, mountain8 wrote:

    I get my sports at a sports bar for the price of a couple beers and some wings.

  • Report this Comment On August 07, 2010, at 12:34 AM, mk96804 wrote:

    The weakness of Netflix is the limited number of movies you can watch on demand. Some may say I watch too many movies but I would say I am part of many people who like to watch a lot of movies. IF Netflix cannot keep up with the demand for NEW movies the rack becomes stale and I, along with other customers, will move on. The drop off will come in waves and come quickly. None of us are loyal to Netflix. We just want LOTS of good movies, cheap and on demand.

  • Report this Comment On August 07, 2010, at 6:38 AM, TMFZahrim wrote:

    mk96804, you are not alone. If you build it, they will come, and Netflix is working on building that digital library as fast as it can.

    There is some progress to report:

    http://www.fool.com/investing/general/2010/07/06/netflix-get...

    ... and CEO Reed Hastings often says that the profits are low simply because Netflix pumps whatever extra cash it has laying around into buying more streaming licenses. Chicken-and-the-egg kind of thing, and it's hatching.

    Anders (master of half-baked metaphors)

  • Report this Comment On August 07, 2010, at 7:18 AM, BioBat wrote:

    6 months ago, I think you could very well make the argument that there wasn't a huge backlog of former and current movies worth watching on Netflix streaming, however, I don't see how anyone can make that argument today.

  • Report this Comment On August 07, 2010, at 8:10 AM, jb757 wrote:

    BioBat: You can't really get all the sports you want via MLB TV. Your local favorite teams' games are blacked out. You can of course watch replays when a game is over. I think most fans want live games of their home teams.

  • Report this Comment On August 07, 2010, at 11:53 AM, idamoore wrote:

    There are a lot of us out there! The movie nuts, I mean. I usually watch movies at dinnertime. I have

    almost 500 movies in my DVD queue and the same in the streaming queue. Anyone who says they have seen all the movies in streaming is dreaming.

    It is not possible unless one has no other life.

    There are great Italian, French, Russian, etc. movies as well as those B/W classics and film noir movies.

    How many people really want to see Pretty Woman or Dumb & Dumber ten times?

    For $8.99 a month, how can this not be the best choice for movie people? A regular movie ticket

    in my neighborhood, NYC, costs $10 minimum.

    NFLX has been a "sell" for many analysts since

    last fall. Were they wrong? Just look at the

    numbers. And the short sellers may just have to

    eat their little pieces of paper.

    If NFLX goes international, game over. No one

    will ever come close.

  • Report this Comment On August 08, 2010, at 2:10 AM, aminorexx wrote:

    I'd like to know where you get your short interest numbers. The NASDAQ site (http://www.nasdaq.com/aspxcontent/shortinterests.aspx?symbol... and the Bloomberg terminal SI function hold the short interest at 8.4 mm shares for a 3.2 days to cover, while the market cap indicates a 52.5mm share issue, for a 16% short interest. Unless the float is less than 33.6mm shares your 25% number doesn't add up.

  • Report this Comment On August 08, 2010, at 8:02 AM, BioBat wrote:

    jb757, it's only a matter of time before MLB TV, NHL online, etc stop blacking out team home games on the internet. They will absolutely cut the legs out from the local TV networks and take the profits all for themselves. It's a new form of media delivery that they've seemed to embrace and will be much better off for it in the long run.

  • Report this Comment On August 08, 2010, at 4:15 PM, MegaEurope wrote:

    The reasoning behind threat 2, movies on demand seems pretty weak. You are basically just assuming that Netflix will improve their library but cable providers will not. (And of course there are also telecoms to worry about - do AT&T and Verizon have their own content on demand plans?)

    Both sides have advantages and disadvantages. Netflix seems to be more focused and has a stronger brand. But I think it is not a slam dunk and it is questionable whether they are reasonably priced.

  • Report this Comment On August 08, 2010, at 6:21 PM, Acesnyper wrote:

    Net flix has been nothing but a great thing for me both as a user and share holder.

    I personally think it'll stay pleasing me on both matters.

  • Report this Comment On August 08, 2010, at 9:56 PM, Glycomix wrote:

    Netflix hasn't been a bargain. It's high P/E ratios were based on the expectation of huge growth. Its earnings continue to jump by leaps and bounds(25%), but its costs have jumped also.

    Overblown expectations is the problem. The increase in earnings couldn't be maintained. The problem is what is a reasonable level for the stock. Standard and Poor's report suggests that Netflix's "Fair Market Value" is $95.40

    Not that Netflix isn't doing a good job. It reported a 25% increase in profits; it has a Return on Assets of 21%

    However, it's overpriced! It's net profit margin is only 7.3, its P/E is 61.1x and Its Price/ book is 75.6x. It has a total debt to equity of 1.34, and its current and quick ratios are only 1.71. That's barely adequate for a hot growth stock. They do have a good business model of suggesting movies that match subscriber's profiles.

    However, we have to be realistic. Mary Buffet said that Warren told her that no business is worth 61 times earnings, and three times sold out his holdings when he found the average stock to have P/Es this high. Each time he sold at the top of the market and the stocks went down.

    Warren Buffet market opinion deserves respect. From a beginning of only $100,000 for to invest, Buffet has made $37 Billion in the stock market over the past 35 years. He's the most successful investor in the history of the market.

  • Report this Comment On August 08, 2010, at 10:34 PM, Glycomix wrote:

    I left off the percent sign in Netflix's profit margin: it's 7.1%. It has a huge debt-load of 133% of Equity.

    Friday it gained $10 on a day when the market was down. Perhaps Jim Cramer's touting the stock as the N in his CANDIES "core stocks" promoted a buying mood.

    Regardless, I can't see how the price of a stock with a 7% profit margin and a normalized PE of 61.1x will continue to rise.

    Amazon has a vibrant internet sales business as well as a electronic sales of books for the kindle tablet. (That tablet may be the death-knell of print publishing since it hugely cuts publishing costs). However, in order to get the reduced prices everyone would need to buy a kindle tablet.

    .

  • Report this Comment On August 09, 2010, at 1:46 PM, mDuo13 wrote:

    Agreed with both the article writer and Glycomix. Netflix is solid and stable for the foreseeable future, but I don't think it's worth 61 times earnings.

  • Report this Comment On August 10, 2010, at 9:41 AM, gimponthego wrote:

    Skype going public. NFLX's maxed out..after a GREAT ride. You're right, Glycomix, it won't. It just doesn't add up.

  • Report this Comment On August 10, 2010, at 3:20 PM, EricTheRon wrote:

    I haven't analyzed whether Netflix stock is a good buy currently. But as a long-time user, I can say there is no way I would go back to anything where I have to "go somewhere" to get or return movies. So Redbox is just silly in my book--time is too valuable. I also haven't had cable in years, whether with/without on-demand. Who wants to watch a movie with a hundred commercials playing in the middle? Not to mention the ridiculous fees! Who cares if I see a new movie a little later. I'm as much a fan of classic fare and good little known movies--a lot of the new blockbusters are just trash and won't be remembered in 10 years. Anyway, none of these alternates will ever sell to Nexflix subscribers. We're spoiled!

  • Report this Comment On August 11, 2010, at 12:01 PM, wjirish wrote:

    I am an oldtimer and as the leading edge of the Boomers and with old e-equipment I have just subscribed to Netflix 2 months ago. NetFlix couldnt make the experience more delightful. I mail the CD back, get a confirm of reciept the next day, email the new movie is coming and the movie the day after. It couldn't be more systematically pleasant and dependable. My wife noodles around in our movie list and thoroughly enjoys the experience. I write this because inspite of the metrics one applies, it is a totally satisfying and dependable business model.

  • Report this Comment On August 13, 2010, at 4:23 PM, exeter17 wrote:

    You realize JenniferWEB is a bot promoting sites where you essentially steal tv from other sources. At least Netflix is 100% legal.

  • Report this Comment On August 14, 2010, at 9:27 PM, rovobo wrote:

    NETFLIX the top banana in a pretty good bunch,I think netflix rules,for know. I'm watching closely though, with today's technological advances things can change in a heartbeat,and I'm not a cardiologist

    ROVOBO

  • Report this Comment On January 08, 2011, at 10:10 PM, SurfChannel wrote:

    What bollocks! I've been using http://freetubetv.net for some time and I think it's much better and you can't beat the price!

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