Having activist billionaire investor Carl Icahn publicly mulling a hostile takeover of Netflix (Nasdaq: NFLX ) has revived its sickly stock, but that really raises the question of whether the Internet streaming service is worth acquiring in the first place.
Looked at another way, if all investors can hope for from Netflix is to be acquired by someone -- Microsoft (Nasdaq: MSFT ) and Amazon.com (Nasdaq: AMZN ) are most often broached as possible buyers -- what will they get out of it that the movie service can't achieve on its own? After all, Icahn really doesn't want to own the company outright; his nearly 10% stake is merely a means of trying to shake up the management team, though he does think someone else ought to step in and buy it.
And Netflix itself doesn't want to be bought out. It adopted a so-called shareholders' rights plan that will dilute the heck out of the stock should someone acquire 10% or more of the company's shares, but these types of deals are more appropriately viewed as "management entrenchment" plans, because they typically preclude management from being ousted. So whether you think Reed Hastings and his team are on the right track or not is probably how you'll come down on the value of the rights plan.
It's still sticky
Obviously, there's some value to be found in its DVD library, but the real prize is found in the subscriber base for its Internet streaming service. That is the future of movie viewing, and though Netflix suffered a lot of blowback from severing its streaming business from the DVD one (I was critical of the move at the time, even cancelling my subscription in protest -- only to come crawling back a few months later with a streaming-only subscription), it was a move that recognized the reality and positioned the company to take advantage of the situation when it achieved critical mass.
Hitting the multiplex
Yet unlike the DVD business, the streaming one is attracting a lot of competition, and that may dilute the value of what Netflix can achieve.
Of course, there's Amazon's streaming service, but we also have Hulu, Vudu, and even YouTube with its own channels. Cable operators such as Comcast (Nasdaq: CMCSA ) are developing competing services, and one can easily see Cablevision's (NYSE: CVC ) app for viewing shows anywhere in your home expanding one day to watching shows anywhere (earlier this year it launched HBO Go and MAX Go to expand to 12 the number of channels you can watch away from home if they're part of your paid service).
Verizon (NYSE: VZ ) is running a pilot program with Coinstar (Nasdaq: CSTR ) to test out a Redbox Instant service. Some 500 Verizon employees get access to a monthly selection of DVDs from Redbox's kiosks, as well as being able to rent or purchase for download movies online. Verizon, which owns almost two-hirds of the joint venture, expects to roll it out by Christmas. AT&T (NYSE: T ) offers access to more than 250,000 TV shows, movies, and video clips for free through its U-Verse service. Importantly, Ma Bell just committed to spending $14 billion over the next three years to expand its high-speed fiber optic network by a third, bringing in an additional 8.5 million subscribers to its U-Verse.
In short, there's no end to the competition Netflix will face in the future, as anyone with content will be able to find an outlet available for consumption. Content is king, and Netflix no longer has a lock on it.
Welcome to diworsification
That's why it switched gears to become a content creator itself. In a move that can only be likened to how Time Warner's (NYSE: TWX ) HBO moved from only showing movies to creating original series, Netflix is investing in a several programs, including Lilyhammer, House of Cards, and an Arrested Development revival. Sure, it might be a means of increasing its leverage with the movie studios to ensure it has plenty of content made available to it -- if you don't give us decent pricing on your movies, we'll make our own shows to compete with you -- it could also blow up in its face if it's not well received. It has 20 million subscribers studios want to access, but the exclusivity of that base might not exist much longer.
I think Netflix is wading in deep waters for which it's not prepared, and investors would do well to use caution. The Icahn rally has caused the stock to rally 20% over the past month, but with a poison pill defense in place, no real interest yet from anyone wishing to buy the company, growing competition, and new ventures outside its core competency, there's a lot of risk for a share-price collapse again.
The stock is already volatile, bouncing between $80 a share and $50 -- and back up again. I think it's likely that if you think Netflix can pull off this scheme and want to get in on the action, you'll have better price points yet to do so. As for me, I plan on staying on the sidelines since I'm not certain it can succeed.
Scarcity of value
Even with all the turmoil and uncertainty, Netflix still trades at ridiculous valuations. Of course, it's always done so, but there seems to be even less rationale than usual that it should trade at 177 times expected earnings, and with its enterprise value going off for more than 54 times the free cash flow it produces, it's not a bargain stock.
While I won't be putting my money into play here, I will be rating Netflix to underperform the broad market indexes on Motley Fool CAPS, the 180,000-member-driven investor community that translates informed opinion into stock ratings of one to five stars. You can let me know in the comments box below whether you disagree with my assessment that Netflix is becoming a fading B-list actor.
Ready for a rubber match
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