This week, as I opened my red Netflix (NASDAQ:NFLX) mailer, I spotted something different. Instead of the standard free trial offer that I could pass on to friends, the mailer contained an advertisement for Dale & Thomas Popcorn. Apparently, one can get more than just movies by mail -- popcorn travels, too!
Netflix investors had pondered the possibility for years, and the Gardner brothers asked CEO Reed Hastings about advertising in this 2003 interview. But despite Hastings' change of heart, I just don't see this latest development as sufficient justification for Netflix's current price.
Is it a good idea for Netflix to advertise ancillary products alongside its DVDs? Of course. I'm sure that many companies are hard-pressed to find a more focused audience for their products. Will it bring Netflix more money? Yup. That growing horde of 4 million subscribers who watch at least four to five movies each month is a prized demographic for more than just popcorn sellers.
But that still doesn't mean you should buy shares at these levels. (Don't short them, either -- but that's another column.)
Advertising in mailers is the latest in a string of logical new features that bring a little more money into the company's coffers. It follows Netflix's deal to annexWal-Mart's (NYSE:WMT) subscribers and cross-advertise with the retailing giant, and Netflix's decision to sell used DVDs to customers for just under $10 each. But glance at the latest income statement and you'll see that monthly rental subscriptions remain Netflix's bread-and-butter business by far. That main business carries a lot of risk for a company with Netflix's $1.5 billion market cap.
While competition from Blockbuster (NYSE:BBI) appears to be contained, corporate tax will start eating into the company's profits once Netflix runs out of the tax-loss carryforwards that it accumulated during its start-up days. Then there are the approaching postage-rate increases that Netflix probably won't be able to pass on to subscribers. (The company has stated that its churn rate is tied to the price of its plans, so I'm assuming that its three-DVDs-at-a-time plan will stay at $17.99 for the foreseeable future.)
That churn rate is Netflix's biggest risk. It's coming down -- top-line customer churn was 4.3% as of the latest earnings announcement -- but not nearly fast enough. Though subscribers are signing up by the hundreds of thousands, investors shouldn't forget those customers who quietly slip out of the party through the back.
Netflix's current torrid growth can't continue forever -- but right now, Netflix is priced as if it will. The company is currently forecasting pre-tax income of $50 million to $60 million (which is about $36 million to $40 million after taxes) next year, which still prices its stock at 43 times 2006 earnings. As far as I'm concerned, no amount of advertising on those red mailers will justify such lofty expectations.
Rewind for further Foolishness:
Netflix is a Motley Fool Stock Advisor recommendation.
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Fool contributor Marko Djuranovic does not own shares in any of the companies mentioned.
