I'm worried. I've been a shareholder -- and subscriber -- of DVD rental giant Netflix (NASDAQ:NFLX) since 2002. The one constant through all this has been the persistent vision of CEO Reed Hastings. He's a realist. He's a straight-shooter. He knows where to pick his battles. He knows that broadband video is the inevitable next step in renting movies at home.
However, something that he said during an interview last week with The Wall Street Journal left me feeling an eerie sense of deja vu.
"We're forecasting around 2 million this year in net additions," he said, referring to the company's projected net subscriber growth, despite the feisty presence of Blockbuster (NYSE:BBI). "They're forecasting around 2 million net additions. The amazing thing is that that's 4 million net additions total, that the market is growing that fast."
It sounds good, until you begin to wonder about the catalysts that will drive a record number of new subscribers to the convenience of DVD rentals by mail. They're just not there.
Before I get into why I believe Netflix's optimism is misplaced, let me recast this scene. Instead of early 2007, let's pretend this is early 2006. Playing the role of Netflix: XM Satellite Radio (NASDAQ:XMSR). Sirius (NASDAQ:SIRI) will be reading Blockbuster's lines.
One plus one is sometimes less than two
At this point last year, XM and Sirius were feeling a little cocky. After closing out 2005 with 2.7 million more accounts than it started, XM felt that it would add more than 3 million net new subscribers, to top the 9 million mark.
The Sirius camp felt equally inspired. It had acquired 2.2 million net new subscribers in 2005. It felt that it could add another 2.7 million net subscribers in 2006, before bumping its 2006 target to as many as 6.3 million total subscribers. Could Sirius and XM really tack on more than 3 million net new satellite radio fans apiece?
This is where simple math can burn you. XM and Sirius thought the satellite radio market could expand by 6 million in 2006, without considering a few things:
- How much of my rival's growth will come at my expense?
- Could any disruptive technologies cut into my product's popularity?
- What will investors do when the sector, as a whole, burns them?
We all know how it turned out for XM. It had to hose down its guidance three times last year, ultimately adding only 1.7 million to its patron headcount. Sirius held up much better, producing more net new subscribers than its larger rival during every single quarter of 2006. Unfortunately, that was only enough to close out the year barely over the 6 million mark.
The mother of all casting calls
What went wrong? How did two fast-growing companies that typically seemed to err on the conservative side of growth prospects combine to land just 4.4 million net new subscribers, instead of the 6 million they figured were in the bag?
XM and Sirius were successful in getting their receivers in more cars last year. The shortfall came at the retail level, where folks were too busy snapping up MP3 players, GPS devices, and multimedia cell phones to invest in satellite radio.
Satrad's original enemy was terrestrial radio. That was an easy competitor to swat, with its long commercial breaks and repetitive play lists. But its ultimate backbreaking competition came from music-playing handsets and the runaway popularity of Apple's (NASDAQ:AAPL) iPod.
Care to overlay that to mail-order DVD rentals? The inconvenience of shuttling off to physical stores with limited inventory and restrictive viewing terms has made Netflix such an easy sell. Do you see that changing? I do. Now that I can have Amazon.com (NASDAQ:AMZN) deliver a rental -- or a purchase -- directly to my TiVo (NASDAQ:TIVO), I've had to redefine the meaning of convenience.
Apple threw a wrench into satellite radio's plans for global domination last year, and it's not doing Netflix any favors in 2007. Selling digital videos through iTunes is a hit. Apple has delivered 50 million TV-show episodes, and more than 1.3 million movies. With last month's introduction of the AppleTV, more of users' home theater viewing time will be spent broadcasting digitally delivered content. Even the popularity of video-sharing sites may threaten the time we spend ripping open those red rectangular mailers to see the latest Netflix release.
The high hurdle of 4 million
I'm not bailing on Netflix, but I believe that Hastings is wrong in assessing the collective growth of the market. Blockbuster is a lot like Sirius now. It has the momentum. It's spending a ton of money to get noticed. (Blockbuster's Total Access marketing campaign is pricey, as was Howard Stern's deal with Sirius, which ultimately turned the subscriber-acquisition tide in its favor.)
Sirius became the retail darling, unjustly attacking XM by branding itself the only entirely commercial-free service -- even though XM ultimately had more commercial-free music channels, beyond its five ad-saddled ones. Blockbuster became a retail darling over the holidays, attacking Netflix as a delivery slowpoke relative to Blockbuster's in-store exchanges -- even though Netflix is the only service with some of its titles available for even more convenient online streaming.
Maybe Netflix gets its 2 million. Maybe Blockbuster does. I just don't think that both will be able to do so. One will grow at the expense of the other, even if many of Blockbuster's signups are cannibalized from its own bricks-and-mortar customers.
There are just too many changes in the wind. Broadband delivery is coming sooner than we think. The potential market for DVD subscription services isn't as thick as Netflix and Blockbuster think.
So can you blame me and my deja vu? I lived through this with XM. The fading satrad star was a painful Rule Breakers newsletter recommendation of mine, and it continues to fall, even after the sell recommendation was issued late last year.
Though Netflix and Blockbuster seem enthusiastic about 2007's potential, I think it will serve up a difficult challenge. How well Netflix weathers that storm will go a long way toward defining -- and probably redefining -- Hastings' amazing legacy.
To Netflix or not to Netflix? That is the question.
Netflix, TiVo, and Amazon have been recommended to Motley Fool Stock Advisor newsletter subscribers. XM is a former Rule Breakers selection. If you've got the time, a free 30-day subscription to either stock picking service is waiting for you.
Longtime Fool contributor Rick Munarriz has been a Netflix subscriber -- and shareholder -- since 2002. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. He also owns shares in TiVo. The Fool has a disclosure policy.
