There's no more rumble in the rubble at Netflix (NASDAQ:NFLX). Days after announcing a profit-sapping price cut and posting its first sequential dip in quarterly subscribers, it seems pretty safe to walk among the ruins.
Rival Blockbuster (NYSE:BBI) finally announced a price increase on its unlimited Total Access plan. Netflix is still expected to turn a profit at a lower price point. The company even got a favorable mention over the weekend in the typically cynical Barron's, of all places.
There's a cool hush around Netflix, but it's not necessarily a comfortable kind of quiet. See, I've rented enough cheesy horror flicks from the company to know where we are in this scarefest. There's been a lot of carnage lately, and the villain appears to have been slain. The uplifting music kicks in, but something's wrong. The end credits aren't rolling. Something horrible is about to happen. There's one last slasher scene to go.
So maybe, just to play it safe, Netflix should consider snuggling up inside the protective arms of Amazon.com (NASDAQ:AMZN). I know that the buyout chatter has been going on for ages, but there's a sense of urgency growing amid the theatrical silence.
I wish I were wrong, but if I were, wouldn't the end credits be rolling by now?
Paradise
can be problematic
I'll tell you why I'm uneasy. I've been a Netflix investor -- and subscriber -- for five years. Something just doesn't feel right. I guess we can start with the misleading optimism that was pouring out of the pages of Barron's.
Eric Savitz's Tech Trader column is upbeat on Netflix. That's a reversal for Savitz, who points out that his bearishness once stretched back to February of 2004, just as the shares were peaking.
He makes many of the sound arguments that Netflix bulls like to make. The company's got a cash-rich balance sheet relative to Blockbuster's debt-laden ways. Blockbuster has to raise prices. He even gives a sound argument for having Amazon snap up the leader in mail-order DVD rentals.
But not only does Savitz fail to realize that Blockbuster is already raising prices, but he also makes a critical valuation mistake. He uses the midpoint of the company's profit guidance for 2007 -- $0.69 a share -- to argue that Netflix is cheap at just 14 times this year's earnings.
Big mistake. See, Netflix has already earned $0.55 a share through the first half of the year. Now that the company has lowered prices on four of its plans by a buck to stay competitive with Blockbuster -- despite May's postal hike -- the mid-point of the company's profit outlook implies $0.07 to $0.21 per share in earnings over the second half of the year. Oh, and more than half of that will come from the roughly $10 million in passive interest income it will generate on its greenbacks in that time.
In other words, analysts already expect earnings to dip next year. Making a case based on rearview-mirror profitability doesn't make sense when the road ahead is bumpier.
But perhaps the most troubling thing about the article is that Savitz notes, "Blockbuster will cry uncle and raise prices" when it did so nearly two weeks ago. The company's unlimited Total Access plan that once set subscribers back $17.99 is now being offered at $24.99.
Nice? Not exactly. Put away the party hats and noisemakers, my fellow Netflix owners. Blockbuster essentially offered up a laundry list of pricing plans. First, it's grandfathering in the existing 3.6 million Total Access subscribers (for now) at $17.99. In other words, churn should be kept in check with subscribers who know that higher prices await if they stray. Returning prodigal sons will be hit with higher cover charges. Blockbuster's new offerings also include a similarly priced $17.99 plan for new members that caps the free in-store exchanges at five flicks. In short, there are 11 new plans at Blockbuster, priced as low as $4.99 a month.
Subs keep coming
DVD rentals with an online interface still make up a growing market. Blockbuster and Netflix combined to add 545,000 subscribers this past quarter. OK, so Blockbuster accounted for 600,000 of those, as Netflix wrapped up the period with 55,000 fewer subscribers. The industry still gained more than the 400,000-ish it picked up during the same quarter a year ago.
|
Net Adds |
Netflix |
Blockbuster |
Total |
|---|---|---|---|
|
Q2 2007 |
(55,000) |
600,000 |
545,000 |
|
Q1 2007 |
481,000 |
800,000 |
1,284,000 |
|
Q4 2006 |
654,000 |
700,000 |
1,354,000 |
|
Q3 2006 |
493,000 |
150,000 |
643,000 |
|
Q2 2006 |
303,000 |
100,000 |
403,000 |
|
Q1 2006 |
687,000 |
100,000 |
787,000 |
Maybe we shouldn't be too concerned. The second quarter was a seasonal dud last year, too. Blockbuster's new plans at higher price points may send new blood Netflix's way. You also have the perpetual pummeling of bricks-and-mortar chains like Movie Gallery (NASDAQ:MOVI), leaving movie buffs with little choice but to turn to mail-order providers.
I'll see you, and I'll raise you a few more ominous concerns. Churn picked up at Netflix, with its first dip in subscribers arriving during the same quarter in which it made online streaming available as a bonus to paying members. The Blockbuster physical stores are out of whack if you're not following that BBI has landed nearly twice as many Netflix subscribers over the past nine months. This may seem encouraging on the whole, but I'd argue that folks either crave a physical store presence, or that Blockbuster was simply converting its own customers. Either way, it doesn't bode well for Netflix.
Death to smooching
So why Amazon? Companies like Amazon and Apple (NASDAQ:AAPL) are migrating consumers to set-top digital delivery. It's not going to happen overnight, yet Amazon would love to get its hands on the 6.7 million celluloid-hungry subscribers that Netflix watches over. With an enterprise value of $770 million, Netflix can still command a healthy buyout premium to that and still be a good deal for Amazon.
I won't go over the many other reasons why Amazon should buy Netflix. I did that two months ago. My emphasis today is on why Netflix should listen. Netflix investors know that a cash-rich Netflix can afford to be patient. It can wait until Blockbuster succumbs to the vicious nibbles of its creditors.
I wouldn't do that. New Blockbuster CEO Jim Keyes has the chops to turn around the retail side of Blockbuster. If he succeeds, Blockbuster can always use Total Access as a loss leader to get folks into the stores. If that happens, Blockbuster will be the one that can afford to undercut Netflix, for a change.
If Netflix waits too long, it also places the inevitable digitally delivered revolution that much closer to the masses. Netflix will be a player there, but not the player.
I know that CEO Reed Hastings is one of the coolest CEOs around, but this is also the same guy who felt that Netflix could tack on another two million subscribers in 2007 just four months ago. Is that the visibility you want, when Amazon would clearly love to pay a fair price for your shares now?
I'm not suggesting that Netflix give itself away, but I think it needs to reassess what it thinks it will be worth in the future. There's still time for a happy ending. Hurry up, end credits, before that maniac pops out of the shadows for one last attack.
Some more thoughts on Netflix:
Netflix and Amazon.com are recommendations for Motley Fool Stock Advisor newsletter subscribers. Finding out why is just a 30-day free trial subscription away.
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. The Fool's disclosure policy covers its eyes during the scary parts.
