How Low Can Netflix Go?

The high cost of oil (settling above $53 today) is taking a bite out of our gross domestic product, according to Fed Chairman Alan Greenspan. In a speech at the National Italian American Foundation today, he said, "So far this year, the rise in the value of imported oil -- essentially a tax on U.S. residents -- has amounted to about three-quarters of one percent of GDP."

It's almost enough to make you kick your gas addiction and bike to work, isn't it? Fool Seth Jayson does. Then again, he's battling all sorts of other addictions.

In today's Motley Fool Take:

How Low Can Netflix Go?

By

Rick Aristotle Munarriz (TMF Edible)



Limbo is a game for the agile. However, if you ask a company like Dell(Nasdaq: DELL), it will tell you that just because you're agile and can bend lower than those around you, that doesn't mean you want to challenge them to a game of limbo.

Netflix(Nasdaq: NFLX) cranked up the Belafonte and lowered the stick last night when it announced that it would be lowering its subscription rates next month. Investors responded with a limbo of their own today, sending shares down 40% to $10 and change, marking a new 52-week low for the company.

The news comes as a shock for two reasons. The first is that over the summer it had bumped up the rate on its basic plan, which allows for three DVD rentals out at any given time, from $19.99 to $21.99. Dropping it down to $17.99 a few months later doesn't give an investor a whole lot of confidence that the company is thinking its pricing strategies through.

The second reason why the news is alarming is that Netflix seemed to be doing just fine with the higher membership plans. Last week it announced that it wrapped up September with 2.2 million subscribers, a 73% improvement over last year's tally. That upbeat spurt was acknowledged last night when the company reported quarterly earnings of $0.29 a share as revenue nearly doubled to $141.6 million.

However, all that growth is out the window as the company says it will likely only break even next year due to its cutthroat pricing strategy. Before you wonder why Netflix would do such a thing, it's worth mentioning that during its conference call, the company said that several sources indicated that Amazon(Nasdaq: AMZN) was readying a similar service.

So this scorched-earth retreat isn't entirely baseless. The competition was already starting to drool when Netflix hiked its monthly rates back in June. Wal-Mart(NYSE: WMT) had been at $18.76 for some time, but Blockbuster(NYSE: BBI) showed a rare case of perfect timing by rolling out a decent Netflix clone at the old Netflix price of $19.99. Netflix seemed to take this all in stride, yet it seems as if Amazonian whispers caused it to flinch.

The stock is naturally taking a beating this morning on the news. While the company was teasing the market last week with higher earnings projections and visions of gross profit margins topping the 50% mark, it was all rescinded awfully quickly.

The end result is that Netflix will keep its pie. It has the 2.2 million subscribers. It has the lean overhead and an efficient and established network of distribution centers. Wal-Mart, a fiscally sensible company, will take a look at its hand and probably fold if a much larger player is willing to play a break-even game. Blockbuster will stick around because it has more at stake. It also has its free in-store rentals to give its mail-order DVD rental service something distinctive.

And what about Amazon? As powerful and knowledgeable as it may be when it comes to e-commerce, if it did have a new service in the works, it doesn't stand a chance unless it prices its offering below Netflix's reduced price. This might be the move that keeps the monster under the bed in the near term.

So, sure, Netflix can get back to its pie. It's definitely a growing one. But shareholders will be quick to notice that the pie is missing something in terms of taste. Limbo is for losers.

Longtime Fool contributor Rick Munarriz has been a Netflix subscriber -- and investor -- since 2002. He is part of theRule Breakersanalytical team that will be looking to unearth the next Netflix -- while it's still in Pampers instead of Depends.

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Discussion Board of the Day: Great Movies

With Netflix's lower subscription plans likely to sway even more members, have you rented any incredible DVDs lately? How big is your Netflix queue these days? What is the greatest film of all time? All this and more in the Great Movies discussion board. Only on Fool.com.

Sun's Investors in the Dark

By

Seth Jayson (TMF Bent)

The more I stare at the recent results from Sun Microsystems(Nasdaq: SUNW), the more I'm reminded of Peter Lynch's frequent -- and hilarious -- remarks about Sun competitor IBM(NYSE: IBM). No matter how much he tried to figure it out, or when he bought the stock, IBM always left him baffled and sorry he'd held it.

To judge by the confusing numbers and tumultuous conference call yesterday, Sun may end up leaving many investors feeling the same way. To begin with the nitty-gritty: Sun's quarterly loss was less than last year's, coming to one negative nickel per share instead of -$0.09.

But that second consecutive increase in revenues touted in the headline to the earnings release? Almost a whopper. The reported 3.6% sounds pretty slim already, but when you strain out the 3% gimme resulting from the dollar's continued freefall, the progress stands at a measly 0.6%. (Yeah, nice of them to leave that little tidbit out of the release.)

If that's not enough reason to convince you Fools to check out the conference call, yesterday's sparring between inquisitive analysts and tight-lipped management should make you reconsider. These folks ducked more questions than the presidential candidates.

Among the un- and poorly explained mysteries: What's the deal with the big drawdown in backlog? What are the real numbers of the AMD(NYSE: AMD) Opteron servers Sun keeps braggin' up? Why the decline in SPARC server units? What's likely to be the state of margins going forward? What are the specifics of the new initiative to give away hardware in exchange for service contracts (and vice-versa)?

Here's a question for prospective investors to answer. Is this the kind of company you want to do business with? Even when you get the answers you want, it's tough enough to judge the prospects of a firm that's slugging it out with heavyweights such as Hewlett-Packard(NYSE: HPQ), IBM, Dell(Nasdaq: DELL), Red Hat(Nasdaq: RHAT), Microsoft(Nasdaq: MSFT), and others. How on Earth would you put a value on Sun's prospects?

With much confusion, it seems. The dizzying variation of analyst predictions for Sun's 2005 runs from -$0.11 to $0.25. Leave the stock alone until events or management shed some light on future prospects. This sun may not rise for a while.

For related Foolishness:

Seth Jayson thinks Sun's technology looks pretty nifty, but he prefers a bit more candor from management. At the time of publication, he had positions in no firm mentioned. View his stock holdings and Fool profile here. Fool rules are here.

Quote of Note

"If it weren't for baseball, many kids wouldn't know what a millionaire looked like." -- Phyllis Diller

Trouble at Marsh & McLennan

By

Bill Mann (TMF Otter)

Yesterday, New York Attorney General Eliot Spitzer dropped a lawsuit on Marsh & McLennan's(NYSE: MMC) insurance brokerage operation, claiming that the firm, in collusion with several other insurance companies, fixed prices and rigged bids to generate larger commissions from big insurers. Spitzer has in hand two guilty pleas from now-former AIG(NYSE: AIG) executives who admitted to scheming to defraud insurance customers in activities that include price-fixing and bid-rigging. Their cooperation in this case not only puts Marsh at risk, it also could potentially spread to the highest level of executives at AIG, the country's largest commercial insurer.

Other companies named in the civil suit were Hartford Financial Services(NYSE: HIG), ACE Ltd.(NYSE: ACE), and Munich-American Risk Partners. The attorney general's complaint (.pdf file) enumerates a long-standing scheme among Marsh and the insurance companies to defraud companies and individuals by overcharging them for insurance. In the bid-rigging scheme, the insurance companies would provide "B quotes," extremely highly priced policy offers that Marsh would use as a comparison to another company's above-market quote, which would then look reasonable in comparison. Each of these companies pays Marsh under a contingent commission basis. These commissions tend to be based on the amount of business the insurer receives from the broker, the renewal rate thereof, and the profitability of the business.

To consider why this is bad, understand what it is that Marsh's clients pay it to do: companies and individuals who need insurance, rather than trying to figure such a complicated market out themselves, go to Marsh to serve as their advocate. Marsh figures out their insurance policy needs and then goes out into the market to negotiate with carriers on clients' behalf to maximize coverage at the lowest possible price. So if Marsh has side deals to steer deals to one insurance company or another -- even if they are disclosed to the customer -- the end result is that it has a built-in conflict of interest. And as the lawsuit spells out in lurid detail, this conflict seems to have become too much of a moral hazard for Marsh. A Marsh executive told the attorney general that these contingent commissions amounted to about $800 million in revenues for Marsh in 2003.

In his news conference yesterday, Spitzer absolutely savaged Marsh, saying that he was "misled at the very highest levels of that company" and that he very possibly might press for criminal charges against Marsh to go along with the civil suit. He also noted that evidence that his office has uncovered thus far suggests that illegal practices extend to every major insurance broker through every line of insurance. Marsh is the largest American insurance broker: Its biggest competitors, Aon(NYSE: AOC) and Willis Group(NYSE: WSH), have also received subpoenas, but have not been implicated in bid-rigging at this point.

Contingent commissions are a long-standing practice in the industry and are not illegal. But Marsh claims that it considers its customers' interests above all when binding insurance, and such blatant conflicts have rightly been questioned for some time. Now it looks like the conflict was even worse than widely perceived. I'll provide more coverage on this in my regular commentary column on Monday.

Want more? See also:

Bill Mann owns none of the companies mentioned in this article. Please view his profile for a complete list of holdings.

Coventry Revives First Health

By

Rich Smith

Four months ago, Motley Fool co-founder and Motley Fool Stock Advisor co-author Tom Gardner penned some prophetic words about his two-time recommendation, managed health care provider First Health Group(Nasdaq: FHCC):

First Health Group has been nothing short of disastrous. Management has consistently overpromised and underdelivered, while spending substantial amounts of capital to buy back stock rather than shore up its business model. I'm not recommending that you sell because I hope FHCC will bring in new management, perhaps in the form of an acquisition.

That was prophetic in two senses. First, in the biblical sense of calling for fire to rain down from Heaven and consume this blighted company and its wealth-destroying ways. Second, in the usual sense: Yesterday, First Health announced that it is in fact getting bought out by Coventry Health Care(NYSE: CVH).

At the time Tom penned those words, First Health was selling for roughly $15. On Wednesday, it closed at $15.04 a share. Forgive the pun, but this little PPO has been flatlining for months now. It was about time someone came along and put it out of its (and its shareholders') misery. On Thursday that happened, and First Health's shares jumped $2.00 in response, closing at $17.04.

Of course, no good deed goes unpunished. No sooner had the buyout news gone out than 11% of Coventry's market capitalization vanished, and McGraw-Hill's(NYSE: MHP) Standard & Poor's placed Coventry on its watchlist for a possible debt-rating downgrade. The reason: Coventry may be overpaying for this underperforming business. Coventry plans to pay for its purchase roughly half in stock (at a 0.1791:1 exchange rate) and half in cash ($9.375 per share of First Health). At Coventry's Wednesday closing price, that would value First Health at $18.75 per share, imputing a valuation of $1.7 billion to First Health. Factoring in Coventry's own share price decline in response to the deal's announcement, however, brings the agreed value of First Health shares down closer to yesterday's close -- about $17.70.

So what's a First Health shareholder to do? One option is to wait around and see whether Coventry can make some money off of this business. Despite having a profit margin just a fraction of First Health's, Coventry sports an almost identical return on equity, so the company is good at doing more with less. On the other hand, First Health shares are now being quoted at close to Tom's June estimate of their intrinsic value. (Click here for a risk-free subscription to Stock Advisor, and we'll give you the magic number.) Sometimes, getting while the getting's good is the prudent choice.

Fool contributorRich Smithdoes not own shares in any of the companies mentioned here.

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