Netflix Makes the Right Move, but It's Still Not a Screaming Buy

This just in: Netflix (Nasdaq: NFLX  ) lives on; Qwikster is stillborn. Now I'm just waiting for R.E.M. to announce a comeback tour, and all will be well with the world again.

CEO Reed Hastings has pulled the plug on the only bad move he made all summer. The inexplicable separation between streaming church and DVD state would have made both services harder to use, and we're only using it at all because it's so darn handy. Take that away, and Netflix customers suddenly have near ly no incentive to stay, you know, Netflix customers.

"There is a difference between moving quickly -- which Netflix has done very well for years -- and moving too fast, which is what we did in this case," Hastings said in a press statement.

Compare that with how I saw the Qwiskter announcement: "This might be the right move to make in 2013 or so, when DVD technology starts to look as quaintly antique as VHS tapes. Not now."

Hastings has come around to my point of view, which also seemed to be shared by hordes of relieved investors today, as Netflix shares jumped more than 11% in pre-market trading. Then shares collapsed throughout the day, though, down more than 3% in late trading. Ouch.

Still, management isn't tone-deaf to the wants and needs of its customers, as I had feared it was. Coinstar's (Nasdaq: CSTR  ) Redbox machines and Amazon.com's (Nasdaq: AMZN  ) fledgling movie-streaming service had a window of opportunity closed in their faces, because a united Netflix remains more user-friendly than a bundle of a la carte alternatives.

Now I'm just waiting for the higher revenues from the almost-separated services to translate into a significantly stronger streaming catalog. If you assume that every DVD customer opts for the low cost of a one-disc plan, that much-maligned guidance update translates into $864 million in domestic sales or a 12% jump from the preceding quarter. That could be a nice boost once Netflix has a full quarter of price changes in effect. A year ago, the second-to-third-quarter domestic revenue jump was just 6.3%.

This makes Netflix a solid buy in my book again. But to earn a spot in the screaming-buy category right next to wildly undervalued camera chip maker OmniVision Technologies, Hastings still has more work to do. He's lost some of my trust, which is an absolutely essential part of any company's real value. To see what Hastings does or doesn't do to renew that trust, you should add Netflix to your Foolish watchlist. Get started, and then soak in all the news and Foolish analysis you can handle on Netflix -- or any other stock you choose.

Fool contributor Anders Bylund owns shares of Netflix and OmniVision but holds no other position in any of the companies discussed here. Motley Fool newsletter services have recommended buying shares of Netflix, Coinstar, and Amazon.com and creating a bear put spread position in Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. You can check out Anders' holdings and a concise bio, follow him on Twitter or Google+, or peruse our Foolish disclosure policy.


Read/Post Comments (6) | Recommend This Article (1)

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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 October 11, 2011, at 2:06 AM, teamonfuego wrote:

    "We believe there are three major barriers to the streaming business:

    1.) It is perceived as being difficult to set up.

    2.) Most users of streaming have a wireless internet connection and we believe there is at least a perception if not a reality that the picture quality isn’t as good because of a potential weak internet signal.

    3.) The business model is not as good because movie studios and other content providers are charging significant fees to stream their content.

    We also believe a significant amount of Netflix DVD by mail customers signed up for the streaming service only because it was offered as a free add-on. This most likely significantly skewed the streaming subscriber numbers. Netflix recently hiked their streaming + DVD by mail combo by 60% from $10 to $16 per month and this most likely resulted in a significant drop in streaming subscribers. We believe Q3 and Q4 Netflix earnings will show that their streaming subscriber base is smaller than the market expects.

    However, even if we are correct in our thesis, we believe it will take time for the market to pay up for CSTR because the perception of the DVD market being a dying one will take time dissipate.

    CONCLUSION:

    Coinstar has several fundamental factors working in its favor. In a struggling economy where consumers are focused on saving money, we believe the $1 a night DVD rental from Redbox kiosks will ultimately be a big winner in the home entertainment industry. Should threats from movie industries or debit card fees come to fruition, we believe Redbox has the room to increase prices by up to 50-100% and still be viewed as a cheaper alternative to anything else in the home entertainment category.

    We also believe the Coinstar coin change machines and several other ideas in the works at coin star, including the used electronics vending machines called Gizmo and Seattle’s Best coffee vending machines, could provide even more upside to CSTR’s stock.

    Based on a 25% average annual growth rate in revenues over the next three years, discounting projected 2014 earnings of $8.25 per share to today, and accounting for a 15 times EPS multiple, we believe CSTR should be worth as much as $80 to $100 today. "

  • Report this Comment On October 11, 2011, at 7:06 AM, TMFZahrim wrote:

    Wow. Let me just cherry-pick one "barrier" to rip apart:

    "2.) Most users of streaming have a wireless internet connection and we believe there is at least a perception if not a reality that the picture quality isn’t as good because of a potential weak internet signal."

    This can only be true if the WiFi connection is the slowest link in your Internet food chain. Even an old 802.11b signal carries data at 11Mbps. 11g can do 54Mbps, and 11n up to 300.

    Compare and contrast to your cable modem (typically no faster than 5Mbps) or DSL (typically no faster than 1.5Mbps).

    A full-quality Netflix stream uses about 2 Mbps of bandwidth. With a slow DSL connection, this scales down and may get noticeably unpretty at times. But the wireless connection is darn unlikely to be the culprit in any case.

    Perception may be different from this reality, granted. But the (unnamed) analyst assumes that it might be true, and needs to learn more about broadband connectivity.

    Anders

  • Report this Comment On October 11, 2011, at 10:04 AM, dlchase24 wrote:

    I agree this is the right move for Netflix. To me, Qwikster made no sense. The problem, however, with so many changes in such a short time is it's making me wonder what's going on with Reed and if he's ever going to make up his mind.

    As a customer of Netflix, my question is can they add content I want to see faster than I can consume (view) their content? I don't think it's any secret the streaming catalog needs to expand and with Netflix focusing more on streaming (even with keeping DVDs) more news on this front seems necessary.

  • Report this Comment On October 11, 2011, at 10:14 AM, CFischer wrote:

    Yeah - or maybe none of this really makes a difference in the stock price, and this stock was driven to absurd highs, far in excess of its fair value, on momentum and speculation by retail longs reacting to cheerleading by websites like this.

    Either or.

  • Report this Comment On October 11, 2011, at 1:25 PM, ikkyu2 wrote:

    a-flippin', and a-floppin'

  • Report this Comment On October 11, 2011, at 4:56 PM, Darwood11 wrote:

    Tale you pick:

    1) At $300 NFLX was a screaming "sell" or

    2) At $109 NFLX was a screaming "buy" or

    3) None of the above.

Add your comment.

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