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An "outperform" call I put on Netflix (Nasdaq: NFLX ) in April 2008 is my very best CAPScall to date, having racked up nearly 900 points. However, it's also a call I actually ended in July, when the stock was trading at $299.51. And now for a new, dire CAPScall: I'm afraid it's time to roll the credits on Netflix as a growth-oriented investing winner.
The DVD disruptor is finally being disrupted itself, and it ain't pretty. Founder and CEO Reed Hastings made a slew of mistakes last summer, which catalyzed the ending of my positive CAPScall. Price hikes on their DVD-by-mail service, the ill-fated (and quickly abandoned) "Qwikster" phase … suddenly Netflix was no longer the darling hero compared to old-school DVD rental rival (and consumer villain) Blockbuster; it just looked a heck of a lot like its old nemesis.
Although the blunders came across horribly, I doubt those missteps were based on arrogance or stupidity. They occurred because Netflix's business outlook is changing dramatically. (Not that that matters to angry, disgruntled consumers.)
Netflix's original claim to fame was that it disrupted the DVD rental business, giving customers a far better experience. Well, now the actual DVD is being disrupted.
First, one major problem for Netflix's physical DVD delivery model is that the U.S. Postal Service is an insolvent mess. The USPS boosted its rates recently as it worked to improve its financial situation. However, many of the things it could do to get its financial house in order would hurt Netflix's financial house. Slower delivery times for first-class mail or discontinuing Saturday delivery are some of the post office's money-saving ideas, but either would both make Netflix's DVD rental service a lot less satisfying.
Granted, eventually how quickly DVDs arrive (or how costly it is to ship them) won't matter. The future is digital. Granted, Netflix worked to get ahead of the game by offering (and strongly encouraging) subscribers to stream content. However, Netflix is most certainly not the only game in town anymore, and I don't believe it has anything close to the competitive moat it possessed in physical DVD delivery.
Amazon.com (Nasdaq: AMZN ) offers streaming movies through its Prime service. In fact, in the midst of writing this, I received a promotional email from Amazon boasting about 2,000 more TV shows and movies added to Prime Instant Video.
Cable and telecom companies like Comcast (Nasdaq: CMCSA ) and Verizon (NYSE: VZ ) offer on-demand options for media consumers. Further, as much as Coinstar's (Nasdaq: CSTR ) Redbox was a formidable threat to Netflix on the physical DVD-rental front, that rivalry got more ammo last week when Coinstar announced Redbox will team up with Verizon to offer streaming titles along with a regular subscription service.
Add in all these issues with the difficulties in courting and keeping studios in their good graces (and offering streaming titles), and I've got a bad feeling about Netflix now. That "bad feeling" is compounded by the fact that the stock's recovered from its dismal lows and is currently trading at 50 times forward earnings.
Time will tell
I know that some of my colleagues, including many on the Stock Advisor team, still hold great belief in Netflix, even given the serious challenges the company faces. (Tom Gardner offered up a thought-provoking analysis in October.)
Still, as great a leader as Reed Hastings has been (annus horribilis notwithstanding), I'm not convinced Netflix can overcome the massive disruption it faces, not to mention defeat the hordes of eager rivals. I'm going to back up the "bad feeling" I have about Netflix with an underperform call on CAPS. (You can see my long-term track record here.) We'll see what the future delivers.
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