The No. 1 Reason I'm Increasing My Netflix Bet

We Americans watch a lot of television -- roughly 190 hours per month, Nielsen says -- but our experience is shifting. Cable subscriptions are declining. Online viewing is up. And "on-demand" is in demand. That's a cocktail of consumer habits that favors Netflix (Nasdaq: NFLX  ) more than most, and one that's been a long time coming.

Nevertheless, just because the revolution is upon us here in the U.S., we shouldn't presume to be leading the revolt. The U.K. is far ahead in developing immersive TV experiences despite having only recently been introduced to Netflix. Why? Credit the BBC. Unlike U.S. peers CBS (NYSE: CBS  ) , NBC, and ABC, the BBC offers a model for what it looks like to take TV beyond the living room.

More on how the BBC operates in a moment. First, allow me to explain why I'm writing this admittedly theoretical piece. In short: I believe that immersive, multichannel TV is coming to the U.S. sooner than any of us think, and that the shift will greatly benefit Netflix.

Disclosure rules permitting, this week I'll be making a trade to capitalize on my belief. Read on to the end for the details of my bet. If you think I'm right, click the "recommend it" button above. If not, post a comment below. I'd love to read your take.

Now, let's take a closer look at what the BBC is doing, shall we?

Better TV, solved
Most of us in the U.S. can't see everything that British television offers because of the restrictions built into iPlayer, a sort of YouTube substitute that plays BBC content for U.K. citizens connected to the Internet. Yet video access is only one of a handful other accessible goodies the network offers to its audience around the globe.

Consider the popular crime drama Sherlock, which stars Benedict Cumberbatch as a modern-day Sherlock Holmes with Martin Freeman cast as confidant Dr. John Watson and Andrew Scott as an updated and particularly devilish James Moriarty. Co-creators Steven Moffatt and Mark Gatiss draw directly from the original works of Sir Arthur Conan Doyle to create the show.

What makes it interesting -- and why it's relevant here -- is the accompanying site with the blog of Dr. Watson, which not only illuminates case details that may not be obvious in viewing the episodes, but also includes off-screen adventures that are referred to on screen. The blog has become a part of the show, and a critical read for fans.

U-S-A! U-S-A! U-S-A!
Yet the BBC's approach isn't entirely unique. Comcast (Nasdaq: CMCSA  ) has allowed its USA Network to experiment with games and other interactive features supporting its slate of edgier shows.

For example, navigate to the site for legal drama Suits, and you'll find eight episodes from Season 1 available to stream plus a series of online games and quizzes. One in particular features "young genius trivia," inspired by the show's plotline, which features a twentysomething former crook with perfect recall who partners with a successful attorney who becomes his mentor.

Netflix has yet to adopt Suits into its "Watch Instantly" inventory, but there have been other dealings with USA Network. Two seasons of White Collar -- another popular drama -- are available now, as are six seasons of the comedy adventure series Psych.

The British connection, and what it means for the long term
My point? Netflix hosts shows but not interactive experiences. And that's a mistake I see Netflix rectifying in time. CEO Reed Hastings said as much in a recent letter to shareholders:

"Our brand is broad, rather than niche, so we can combine the benefits of multiple channels into one service. Additionally, our Internet culture enables us to create and drive social TV, recommendations TV, and other Internet innovations faster than our cable and broadcast network competitors." [Emphasis added.]

To be fair, we don't exactly know what Hastings means by "Internet innovations," but I suspect giving fans more of a voice via a social feed -- fed by the likes of Twitter and entertainment network GetGlue, among others -- plus devices such as Dr. Watson's blog for Sherlock are likely candidates. Anything to increase engagement with the site and its instant inventory as the DVD business winds down.

There's good reason to act fast. Most of the American network and cable operators have shown themselves to be scared of what happens when content appears on the Internet. Executives are afraid ratings -- their bread and butter -- will disappear as the Web disrupts cable, leading to lower advertising revenue. Those are dollars that could eventually shift Netflix's way.

And now ... the trade
In the meantime, I'll be chasing a more immediate profit opportunity. My plan is to buy January 2014 calls at a $60 strike price. This type of option is called a LEAP, for Long-Term Equity Anticipation Securities. In my experience, LEAPs are particularly effective when:

  • You have a strong thesis for a stock you already own or would like to own.
  • You'd like to add more reward to the risk-reward equation.
  • There's a known catalyst capable of driving gains in the timeframe the options are active.

Here, the catalyst is net subscriber additions. Hastings has said that he expects roughly 7 million in new additions for 2012, yet judging by a recent sell-off in the stock, investors believe Netflix won't deliver. And that's in spite of a long history of a management team that's been remarkably accurate when it comes to predicting growth in this particular area of the business.

In planning to buy the $60 calls, I'll be spending to get a modest amount of intrinsic value -- roughly $10 a share, since the stock currently trades around $70 -- to protect against further declines while still allowing for substantial upside.

How much upside? Consider recent history. Netflix traded near $130 a share in February on the back of reporting good subscriber numbers. Were Hastings and team to report 8 million subscriber additions for 2012 next February, topping estimates, investors might bid the stock back to $130, putting the intrinsic value of my LEAP, presumably purchased for $26 a share, at $70. I'd be up well over 100%, and that's before adding in the time value of having 11 months until expiration in January 2014. A double or better seems possible to me.

The option to profit
There are no guarantees, of course. Read our primer to get a better sense of the risks and rewards of using options to enhance investing returns. And if you're unconvinced of Netflix's prospects -- if you'd rather the safer, stable returns that dividends offer -- these nine stocks might be exactly what your portfolio needs right now. Either way, let us know what you think about Netflix, options, and the prospects for more interactive TV in the comments box below.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team and the Motley Fool Supernova Odyssey I mission. He owned shares of Netflix at the time of publication. Check out Tim's Web home, portfolio holdings, and Foolish writings, or connect with him on Google+ or Twitter, where he goes by @milehighfool. You can also get his insights delivered directly to your RSS reader.

The Motley Fool owns shares of Netflix. Motley Fool newsletter services have recommended buying shares of Netflix. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (4) | Recommend This Article (21)

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 May 29, 2012, at 11:15 PM, jb757 wrote:

    A key for optimism is the 1.74 million subs added in 1Q12 after suffering a lowly 600,000 adds in 4Q11. It is said that 2Q12 will be soft because of the seasonality factor but that 2H12 will see Netflix well over the 30 million level in domestic subscriptions. The stock should rise as the numbers become clear.

  • Report this Comment On May 30, 2012, at 1:30 AM, Riskysam wrote:

    Sorry Tim,

    I am just not convinced right now. As a cheap stock? Yes, Netflix is a buy based on fundamentals alone. Yes they will get back their subscribers eventually.

    As a subscriber, i am not interested in the interactive better TV stuff. Fix the darn streaming! If you(Hastings) bet on streaming, then all subscribers should be able to watch the latest flicks on it. Netflix is a convenience not a necessity.

  • Report this Comment On May 30, 2012, at 12:26 PM, dlchase24 wrote:

    You bring up some interesting points, but there is an outstanding concern that prevents me from agreeing with you completely.

    My biggest concern with your idea is the delay between release of the content and Netflix adding it to their library. Using an example you provide, Netflix has two seasons of White Collar. Season 4 starts in July however. So there is at least a one season gap between what Netflix has and what is being released.

    I ran into this issue with my personal viewing with both Sons of Anarchy and Breaking Bad, leaving me a season behind on both if I wanted to pick up viewing as they aired. For Netflix to truly challenge the cable experience, that content gap needs to close. Easier said than done, I know.

  • Report this Comment On May 31, 2012, at 2:22 PM, 48ozhalfgallons wrote:

    Riskysam: One could have not said it better, that Netflix is a convenience not a necessity. There lies the business model. Apple should take note.

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