When a stock takes investors on the kind of ride that Netflix (NFLX -0.51%) has had in the last year, some investors may start to ignore obvious issues. While there is little doubt that the company is blazing a trail in streaming video, there are problems facing both the stock and the company's operations that need to be addressed.
Issues with the old
Clearly, Netflix is not as concerned with keeping its DVD subscribers, and you can tell this by the way the company's earnings reports are structured. In each earnings report, the company talks about its streaming subscribers both domestically and internationally. The company's focus is on growing its original programming and the streaming catalog.
While the DVD division isn't the focus it used to be, it still represents 20% of revenue for Netflix. In addition, this division still contributes more than $100 million in profit . Relative to the $166 million profit from the domestic streaming business, the DVD business is not an insignificant contributor to Netflix's bottom line.
While Netflix is not as focused on this business as in the past, Outerwall (OUTR) is more than willing to take whatever Netflix gives away. The company's Redbox division drives almost 84 % of the company's revenue. In addition, Redbox is investing heavily in getting better results from this division. Redbox revenue was up 7%, while Netflix DVD customers left at a nearly 16% annual rate. Based on these numbers, there is little question that this cash cow is slowly dying.
Issues with the new
If you believe in the Netflix growth story, you have to assume that the company will continue to gain subscribers domestically, while showing impressive growth internationally. With 2.7 million new subscribers in the last quarter, Netflix seems to be doing well. However, an old foe seems to be gaining momentum.
Amazon.com (AMZN -1.14%) is gaining ground with its Prime membership, and the company's Instant Video library is a serious contender to Netflix's dominance. In the current quarter, Amazon indicated it added "millions of new Prime members ," which is similar to the number Netflix added.
In just the last two years, Amazon's Instant Video catalog increased from around 5,000 titles to more than 40,000. While Netflix arguably has more titles, each company offers a compelling value. It's a near certainty that Amazon and Netflix will continue to try to outbid each other for exclusive content. Each company will also surely continue to develop its own content, but there is one big difference between the two.
In the past, it could be argued that Netflix had the upper hand because the company arrived first in the streaming game. The company's placement in many streaming video devices and televisions seemed to give Netflix the upper hand. However, as time goes on and these devices update, newer services, including Amazon Instant Video and Redbox Instant, end up right next to Netflix.
The biggest difference between Amazon and Netflix -- or even Outerwall -- is that Amazon offers a proprietary hardware platform through the Kindle Fire lineup, whereas its competition does not. While some might dismiss this as a non-issue, there is little doubt that a customer who buys a Kindle Fire will be more inclined to use Amazon Instant Video. While it's true that this same customer might also use Netflix, the fact that Amazon can offer special privileges to its Prime members is something that Netflix can't match.
Issues with valuation
Based on 2014 expectations, Netflix sells for about 85 times projected EPS . With analysts calling for earnings growth of about 22%, this gives the stock a PEG of 3.8. This type of valuation is reserved for the fastest-growing companies.
While Netflix and Amazon carry PEG ratios of 3.8, Amazon is expected to grow earnings at a much faster rate. Analysts are expecting nearly 36% EPS growth from the online retailer. If you project both Netflix and Amazon's earnings and growth out to 2015, there is an argument for choosing Amazon over Netflix.
In 2015, Amazon's faster expected growth means the company's PEG would drop to 2.8 compared to Netflix's PEG, which would still sit above 3. However, of the three companies we've looked at, Outerwall seems the best value of the bunch.
Outerwall is expected to grow earnings by 20%, which is nearly the same as Netflix, yet the stock sells for a P/E ratio that is 85% cheaper. If you are a value investor, Outerwall is hard to ignore, but if you want fast growth, Amazon seems like the better bet.
Sorry, Netflix investors. Your company has several problems, and even after all the ups and downs, you can't afford to be complacent. At its current valuation, Netflix investors are expecting perfection. If the company can't deliver, the stock's wild swings will continue.
