A Few Things That Netflix Bears Are Missing

The Netflix (Nasdaq: NFLX  ) rally was fun while it lasted.

Shares of the leading premium video service provider soared 22% last week -- and another 10% yesterday -- on a wave of favorable analyst notes.

The party ended today with Bank of America Merrill Lynch analyst Nat Schindler downgrading the stock. The strong run this month found the stock closing yesterday above his earlier $72 price target. It makes more sense to him to downgrade the investment -- from buy to underperform -- than to bump his price objective higher.

A lack of visibility on when Netflix will turn a profit with its growing international business and concerns on the health of its domestic streaming business are weighing on Schindler's opinion of the company.

He's also concerned about the growing competitive threat posed by Amazon.com (Nasdaq: AMZN  ) , additionally arguing that Amazon has no reason to buy Netflix now.

Channeling Chanos
CNBC's Herb Greenberg is also waxing bearish on Netflix today. In a CNBC.com column, Greenberg rolls out the Chanos rule.

Named after noted naysayer Jim Chanos, Greenberg argues that Chanos believes that growth starts slowing -- if not peaking altogether -- when it sells 25 million to 30 million units or has that many subscribers.

Greenberg's examples include George Foreman Grills, Green Mountain Coffee Roasters' (Nasdaq: GMCR  ) Keurig brewers, and LeapFrog (NYSE: LF  ) LeapPad.

There are even better examples when it comes to subscriber services as everything from HBO to AOL (NYSE: AOL  ) to the country's leading cable and satellite television providers. They've all had a funny way of topping out after penetrating roughly a quarter of the homes in this country.

Netflix is already there. It has just topped 30 million global subscribers, but back in the U.S. it has 26.4 million accounts. There are 23.9 million streaming customers, and just 2.5 million of its 9.2 million disc-based renters don't also pay for streaming.

Should Netflix be worried about its popularity peaking? Greenberg points to a comScore report showing that Netflix's traffic declined in the third quarter.

Got all that? Good. It can be pretty grim.

Battling back
There are obvious flaws in the Chanos rule. Going by that 25 million to 30 million mark, investors would've bailed on Apple (Nasdaq: AAPL  ) several iPhone generations ago.

We're also talking about the only premium video service that's really generating any kind of traction. We can't compare it to individual cable and satellite companies that are carving out what's a little more than 100 million homes in this country that pay for TV.

Oh, and don't put too much weight in that comScore metric. This isn't 2005. Folks rarely engage with Netflix.com these days. Subscribers use Blu-ray players, tablet apps, and consoles to interact with their queues and sort through suggestions.

Greenberg's a sharp guy. He has been rightfully skeptical on Netflix over the past year. However, the Chanos rule doesn't make a lot of sense here.

Green Mountain's Keurig brewers are stateside anomalies. Netflix has international ambitions, going from zero to 3.6 million overseas accounts in less than two years. How big will the international market be? Hastings is "confident" that Netflix will be available in every company with the possible exception of China within 10 years.

The competitive landscape will be different. Amazon is a poorly marketed and difficult to access Netflix Lite, but it's certainly out there. When Apple hits us with a TV service, it would make perfect sense to introduce a video service of some kind. Netflix has already run into some entrenched players in the U.K. as BSkyB and Amazon's LOVEFiLM were already streaming before it arrived. However, if we were going to wipe away Netflix's international prospects from its growth potential, then we may as well wipe out the losses being incurred overseas and admire Netflix as a very profitable domestic operator.

I think there's something to the Chanos rule. It wouldn't surprise me to see Netflix's domestic subscriber growth begin to slow dramatically here. However, that's just one part of the equation. It will then be up to Netflix to see what it can do to milk more than $7.99 a month out of its tens of millions of customers. Hastings doesn't seem very interested in exploring the prospects of pay-per-view rentals or tiered pricing, but it would be a bigger mistake to think that Netflix's revenue-generating potential stops here.

Every rally deserves a break, but to argue that Netflix -- now with 30.1 million global customers and climbing -- has topped out as a global provider of video is at odds with what's really happening.

Stream on
A new premium report on Netflix details the opportunities and challenges in store for its shareholders. The report includes a full year of updates, so time's ticking. Click here to check it out now.

Rick Aristotle Munarriz owns shares of Netflix and Green Mountain Coffee Roasters. The Motley Fool owns shares of Apple, Bank of America, Amazon.com, and Netflix and has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters and short DEC 2012 $21.00 calls on Green Mountain Coffee Roasters. Motley Fool newsletter services recommend Amazon.com, Apple, Green Mountain Coffee Roasters, LeapFrog Enterprises, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.


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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 09, 2012, at 9:35 PM, pauldeba wrote:

    You must not have access to Netflix' slim selection of aged TV offerings. They used to deliver new movies to your mailbox, now they deliver old TV show via Internet. it gets boring real fast, I can't imagine anyone lasts longer than 6 months.

    If 15% of Apple users churned out every quarter, you might have a point, but they don't. Latin America has much higher churn and much slimmer offerings. lovefilm UK has not abandoned DVD and is a fierce rival offering more than just streaming. netflix already failed once in the UK.

    They don't make money and can't on streaming. We will all be streaming in 5 years, but if you think metflix has some kind of monopoly, you are sadly mistaken.

  • Report this Comment On October 10, 2012, at 6:29 PM, BentMike wrote:

    "I can't imagine anyone lasts longer than 6 months."

    You are making the common mistake in thinking all people have the same taste in entertainment. This sort of error in thinking can be troublesome when investing. (See: http://www.jasonzweig.com/brainbook.html)

    Also the there is clearly not that sort of churn in the Netflix subscribership. Just isn't.

    I have been in for several years with streaming and it is my preferred way to watch video entertainment. If I haven't seen a show before, then it is not old to me.

    The $8 a month charge is really quite low. Compared to $40+ for a cable package.

    I don't think NFLX is a monopoly, even though the nearest competitor is amazon which is fractional in comparison, no question they have a big head start. That is worth something if the play it right. So far they have been spot on with guidance. Imagine NFLX in every country but China in 10 years. That would be worth something indeed. I bet RH knows it can be done if he says it - they give high quality guidance, very accurate.

    You gotta be able to see the value in things you don't actually like or want yourself.

    As regards competition in the UK. That is a pretty small market, don't overweight what happens there. NFLX streamiing already goes out to an number equal to half of all UK ,not that that is really useful info. It sounds cool though.

  • Report this Comment On October 10, 2012, at 6:50 PM, BentMike wrote:

    I missed another point, "not making money" is due to building out for the future, not because they are in the red on streaming.

    I wasn't clear about churn either, a portion of that turn over is mitigated by returning customers. NFLX makes it very easy to come and go as you choose. They maintain your preferences and queue even after you stop for a while. I drop in and out of the DVD service.

  • Report this Comment On October 12, 2012, at 4:01 PM, ChrisBern wrote:

    I agree with pauldeba. The Netflix streaming library is just not that interesting from a content perspective. When it was Netflix vs. Blockbuster, it was a no-brainer: Netflix offered a greater movie selection at lower costs if you were someone who rented at least a few movies a month. But Netflix can't afford to license enough content to make streaming as interesting as its DVD service is/was. Maybe it'll catch on internationally, who knows, but that's a riskier proposition and investment than what NFLX was several years ago.

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