Netflix: A Crisis of Confidence

Coming this fall to a school near you: "Gaffes 101: How to Turn a Successful Business Into the Laughingstock of Wall Street in Six Months" -- taught by Reed Hastings.

Watching the drama unfold lately at Netflix (Nasdaq: NFLX  ) is like watching Leon Lett trying to run a fumble back for a touchdown -- it's exciting, but you know it's not going to end well. Just weeks after the company unveiled plans to split the company's business into two separate entities -- streaming video and DVDs -- CEO Reed Hastings abruptly reversed course yesterday and snuffed out the entire concept of Qwikster with a spokesperson for the company claiming, "We underestimated the appeal of the single website and a single service."

Well, folks, I'm banging my head against the wall now more than ever. I can't say I disagree with the decision to keep the company integrated (seriously, who would have ever guessed that users like everything in one place?), but the timing of the decision perplexes me. It hadn't even been three months since Netflix introduced the world to Qwikster, and now it's taking it away before it even made an appearance.

The stock popped yesterday in response to the news but abruptly reversed course and finished the day down more than $5. "Why?" you might wonder. Because shareholders have lost confidence in Hastings' decision-making ability.

Think about it. This isn't the first time Netflix has gotten out of the clown car in the past three months. In July, Netflix announced a 60% price increase to its streaming video and DVD package, with the expectation that it would lose customers from such a large increase. It's not as if the company hasn't raised prices recently, either -- it enacted an 11% price increase late last year. But as Fool and avid Netflix user Anders Bylund points out, it's also not as if the user is getting anything extra for this massive jump in price. Here's the real kicker: In September, the company was forced to revise total subscribership down by 1 million more than its original loss expectations.

Indeed, Christmas has come early for the streaming-video and DVD-rental sector. Coinstar's (Nasdaq: CSTR  ) Redbox, Amazon.com's (Nasdaq: AMZN  ) streaming business, and even DISH Network's (Nasdaq: DISH  ) recent purchase of Blockbuster are all set to reap the benefits of ticked-off Netflix customers. If you haven't noticed, Blockbuster has taken up an advertising campaign squarely against Netflix's DVD business in recent months. When the smallest kid in the class starts picking on you, you know something's wrong.


Growth prospects for Netflix aren't even that strong, either, for two primary reasons. First, the barrier of entry in the streaming-video segment is almost nonexistent. It wouldn't be a shock to see Google, Apple, or Microsoft, with their mountains of capital, enter the streaming-video market in the near future. I also wouldn't be surprised if Amazon, with its $6.4 billion in cash, is able to broker enough media deals to equal Netflix's library size in just a few years.

The second problem I have with Netflix is its lack of revenue diversification. Netflix derives nearly all of its revenue from the United States and, aside from plans to expand into Latin America later this year, has very few untapped roads to new revenue … other than to crush its current customers into submission with price increases.

I really don't know what’s worse -- the original decision to create Qwikster, the flip-flop of that decision, or the fact that Hastings doesn't have a clue what his customers want. Until investors believe that they can trust Netflix, and I don't suspect that'll be anytime soon, I anticipate that the stock price will continue to languish and the mass exodus to Amazon will accelerate.

Putting your distaste for the price increase aside, take the time to vote in the following poll on whether you believe that Hastings has what it takes to keep Netflix relevant in the streaming-video space.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He has thus far resisted the urge to subscribe to Netflix. You can follow him on CAPS under the screen name TMFUltraLong

The Motley Fool owns shares of Google, Apple, and Microsoft. Motley Fool newsletter services have recommended buying shares of Apple, Amazon.com, Netflix, Microsoft, and Google, creating bull call spread positions in Apple and Microsoft, 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. The Motley Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (4)

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 October 12, 2011, at 2:21 AM, Dekabrist wrote:

    NFLX's massive stock market drop is making me feel queazy, which is probably because NFLX is the Titanic of the stock market - nothing could sink it ( everybody decried) ... well, except for the Hastings iceberg. But only one compartment is flooded, you will say. This ship is unsinkable, pass me another G&T, Algimon, and be quiet while I listen to the band.

  • Report this Comment On October 12, 2011, at 2:49 AM, Dcns22 wrote:

    These are definitely problems, but what if analysts overestimated customer loss?

    There was no immediate benefit to paying more, but won't more money coming in bring more content?

    This guy seems to think so...

    http://seekingalpha.com/article/298461-why-netflix-could-dou...

  • Report this Comment On October 12, 2011, at 3:27 AM, TMFUltraLong wrote:

    Dcns22,

    Netflix actually dropped their own guidance in September - it wasn't analyst projections.

    More money could bring in more content. Right now Netflix has more deals in place, or I should say more lucrative deals than say Amazon, but Amazon's cash pile could crush Netflix. Amazon probably has more sway in the future when it comes to negotiating content deals.

    TMFUltraLong

  • Report this Comment On October 12, 2011, at 9:07 AM, cattywampus wrote:

    When the smallest kid in the class starts picking on you, best laugh so far today. Did opportunity just kick down the front door? I hate to be in this group and I would never say this on some other Netflix boards, I mean those are the pod people, who drank the kool aid that infected them with the zombie virus. In my very limited experience I think Hastings did this because people are jumping ship like rats on the S.S. Minnow. We'll see shortly when they report earnings.

    Meanwhile I saved a keg of powder when my rowboat sank.

  • Report this Comment On October 12, 2011, at 9:48 AM, hellerbrewing wrote:

    1) Don't you think it would be a lot easier and more cost effective to backtrack on this decision before the new website is up?

    2) Reed has been making all of these decisions as of late to try to kill off the dieing DVD business, do you think he cares that much if the DVD customers jump ship and go to Blockbuster?

    3) Customers have already started to see the fruits of the price increase to the combo customers in the form of increased streaming content. I think you will continue to see these deals in the headlines going forward. More content = more customers.

    4) Apple and microsoft are already in the streaming video business. Wait... doesn't google own youtube? Haven't they been streaming video for a while?

  • Report this Comment On October 12, 2011, at 11:28 AM, cycorp89 wrote:

    NFLX is a very intriguing company. I foolishly bought into all the marketing hype and obviously paid a high price. However, its quite clear that they are onto something. Perhaps like many other companies as they grow make any number of mistakes. There's still time to correct all that...

    Maybe they shouldn't just focus on the US of A. Apparently in Canada they love it cos there's nothing like it.

    I read an article from a guy in the UK saying the same thing. Perhaps they shouldn't spend on just Content, but cautious expansion internationally.

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