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After the Buzz, a Dose of Reality for Netflix

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This is quickly becoming like a bad investment movie. Netflix (NASDAQ: NFLX  ) announces a billion streaming viewers, international expansion into the Nordic region, or a new, exclusive content agreement, and what happens? Giddy Netflix subscribers/investors buy, buy, buy! The question is ... why, why, why?

The nightmare that is Netflix continued Dec. 5, after its announcement of an exclusive movie rights deal with Disney (NYSE: DIS  ) . Lo and behold, Netflix stock jumped as much as 14% on the news, closing up 13%. Upon further review, Netflix investors are slowly realizing that the deal adds little to a stock that's lived on hype, and not much else, ever since CEO Reed Hastings thumbed his nose at his own customers.

The deal
Beginning with Disney's new 2016 theatrical releases, Netflix has paid for the rights to be the sole U.S. provider of Disney flicks via its streaming service. For Disney's direct-to-video offerings -- in other words, second rate videos -- Netflix plans to make them available to it streaming customers beginning in early 2013.

There's also the multi-year deal that makes old-school classics, including Dumbo and Pocahontas, among others, immediate additions to the impressive Netflix content arsenal. So, what's not to love?

Reality sets in
The concern among much of the media today is what Netflix had to pay for the Disney deal. But the long-term impact to Netflix and, ultimately, its shareholders, goes beyond the size of the check made payable to Disney.

But first, just how much has Netflix committed itself too? According to rumors, Netflix will pay somewhere in the $300 million per year range. The Netflix deal appears awfully steep when compared with Liberty Media's current arrangement with Disney, which expires in 2015, of $200 million per annum for exclusive programming. If it turns out that the Netflix numbers are even close, it paid a handsome premium, to say the least.

When you start to do the math, it's easy to see why all the Netflix excitement is quickly waning after yesterday's buzz. Netflix needs to add about 4 million subscribers, give or take, to break even on the Disney arrangement. Considering that Netflix will add about 5 million net subscribers this year, according to analysts who predict a slowing in subscriber growth, the numbers look pretty daunting.

But even if Netflix is able to use the Disney connection to boost subscribers, it doesn't address its bigger, on-going problem. When Hastings booted his DVD subscribers -- (Okay, he didn't exactly boot them, but he has made it clear he doesn't want that business) -- he put all of Netflix shareholder's eggs into the streaming video basket. The problem with streaming, as it always will be, is razor-thin margins. Last quarter's domestic streaming margin "improvement," up 0.08% to 16.4%, paled in comparison to the margins of the DVD business.

How big is the difference? Even with Hasting's shoving aside of DVD customers, it still generates the majority of Netflix's profit.

Now, the really bad news
It took a while but, according to some reliable rumors -- assuming there is such a thing -- Verizon (NYSE: VZ  ) and Coinstar (NASDAQ: OUTR  ) are getting set to unveil their long-awaited video streaming service. As per a short-lived blurb on Coinstar's own website, the new service will cost $6 a month, undercutting Netflix pricing. Coinstar and its Redbox kiosks will continue to provide DVD alternatives to customers, too. In fact, word has it that, for a slightly higher monthly fee, customers will receive up to four Redbox DVD rentals in addition to its streaming options.

And let's not forget's (NASDAQ: AMZN  ) Prime service, which recently signed a content deal with former Netflix partner, Epix. Could we see separate its streaming business from Prime, to more directly compete with Netflix? Probably.

Then there's the often overlooked elephant in the room, Google (NASDAQ: GOOGL  ) and its YouTube offering. The hiring of Hollywood-level talent is likely a precursor to Google's own foray into Netflix-like streaming services. Comcast, TimeWarner, and satellite TV providers won't be far behind the streaming content movement, either.

Netflix has $798 million in cash on its balance sheet, along with $400 million in long-term debt, flat operating income, and barely discernible earnings; not exactly a confidence-instilling financial statement. Now, factor in Netflix paying a reported $300 million on a deal that will take years to show any bottom-line results,  assuming it ever does. Don't fall for the latest Netflix buzz. As usual, once the euphoria wears off, Netflix still leaves little for investors to hold onto.

The opportunities in streaming media have brought a number of new, deep-pocketed rivals looking for their piece of a growing pie. Can Netflix fend off this burgeoning competition, and will its international growth aspirations really pay off? These are must-know issues for investors, which is why we've released a brand-new premium report on Netflix. Inside, you'll learn about the key opportunities and risks facing the company, as well as reasons to buy or sell the stock. We're also offering a full year of updates as key news hits, so make sure to click here and claim a copy today.


Read/Post Comments (2) | Recommend This Article (0)

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 December 07, 2012, at 10:48 AM, Jermo wrote:

    If the case for Netflix (NFLX) is so bearish then why is it an active recommend buy on TMFSA instead of a Hold or Sell?

    We subscribe to the service for advice and updates. Your comments directly contradict a service that many of us paid for. Which is correct?

    I'm asking because posting something like this in the community forums would be much different than posting on TMF where it can be taken as investment advice.

    As an SA subscriber and a relatively inexperienced portfolio manager (my own) I find it a bit distressing that the company I pay to give me advice doesn't seem to be consistent, clear, and timely on advice and updates.

    Even worse for me. IF not TMF for investing advice then who? I don't see any real options. TMF SA has been pretty good for me.


  • Report this Comment On December 10, 2012, at 11:01 PM, timbrugger wrote:


    Great question; let me try and address your concerns. TMF, unlike a brokerage or advisory service, encourages different viewpoints, ideas, and even recommendations. The objective is to provide investors (like yourself and the millions of other Fools) with sometimes contrary, yet supported, arguments for a stock, or stocks.

    Why? So you are able to incorporate multiple sides of the same investment story (and EVERY investment story has multiple facets), disseminate the information, to then make an informed decision that's right for you.

    Netflix is an ideal example of differing views; and not just within TMF, but across the investment community. Stocks that move wildly on speculation, non-financial news, and the 'comfort' level many individual investors have with Netflix, because they use it, like it, so therefore believe it's a good investment, I am uncomfortable with. Always have been.

    Others don't share my concerns in these areas, and are able to logically support their argument for Netflix. I can't, nor should I, fault them for that - I just happen to disagree.

    I hope that rather long, drawn-out explanation helps!

    Thanks for the post, Tim.

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