Movie rental maven Netflix (Nasdaq: NFLX) has absolutely destroyed the market lately. The stock price has gained more than 150% over the last year, and that meteoric rise has brought critics out of the woodwork. Convinced that this golden age can't last, short-sellers have piled on and now hold more than 25% of the float.
In other words, a lot of people are betting a lot of money on Netflix falling back to earth, preferably to a fiery death.
But what will it really take to kill Netflix -- and how likely are these doomsday scenarios? Let's find out.
Threat No. 1: It's nothing special!
So Netflix is shifting from a rather unique DVD-by-mail operating model into an all-digital download service. To many critics, this is tantamount to filling your business moat with concrete and installing a paved six-lane highway right across it. Digital media is easy, right? Surely somebody else will figure out how to do it better!
Well, it's actually not trivial to beat Netflix at this game (and don't call me Shirley). The company has a serious head start in both technology and Hollywood relations, having worked on both for a decade or more. If you thought that a company named Netflix would be satisfied with mailing red envelopes until the format became a quaint anachronism, you're sadly mistaken.
Hulu and YouTube may seem like serious contenders, but neither one touches the Netflix core market of back-catalog feature films. Apple (Nasdaq: AAPL), Blockbuster, and Amazon.com (Nasdaq: AMZN) do face off against Netflix in that field, but all of them lean on per-rental fees and time-consuming downloads. Netflix is the king of subscription services and instant gratification. The Blockbuster Total Access plan does not include digital movies, though it remains the only true competition to the traditional DVD-by-mail side of Netflix.
All of these potential rivals would need to redefine their business models in order to even step on Netflix's toes. Even then, they're a long way from posing a real threat to a service with more than 15 million sticky subscribers.
Threat No. 2: Movies on demand
I will agree that cable giants such as Time Warner Cable (NYSE: TWC) and Comcast (Nasdaq: CMCSA) hold a potent weapon in their on-demand technologies. Click a button on your remote, and you get a movie -- often a recent hit and sometimes one that's not even available to buy on DVD yet. The 30-day delay on new DVD releases for Netflix is one thing, but the streaming catalog rarely touches anything made in the past few years.
And again, these are two ships passing in the night. The cable guys have a lock on new releases but can't compete with the depth of the Netflix library. This divergence will only grow in the coming years as Netflix sits down with Sony, Time Warner (NYSE: TWX), and the other big studios to hammer out increasingly favorable digital licensing deals. Meanwhile, it seems easy enough to add tons of content to those on-demand menus, but nobody is going there. Shouldn't the cable industry appreciate the value of the long tail more than most?
So here's a real threat but one that's unlikely to go anywhere. The high-margin on-demand model of today is too delicious to trade in for cheap or free back-catalog movies. Netflix goes free again.
Threat No. 3: Redbox
OK, Coinstar (Nasdaq: CSTR) has a hit on its hands with those ubiquitous Redbox rental machines. But if you've paid attention this far, you should see why Redbox doesn't have Netflix shaking in its boots: You're comparing apples to duckbilled platypuses.
The Redbox model aims right for the heart of Blockbuster's rental stores, skirts around the on-demand cable offering, and touches on the fresh-stuff-now libraries of Apple and Amazon. But it's not a digital service, and I don't see a product like that coming up. Redbox does a small assortment of new releases while Netflix goes deep and wide in movie history. Simply put, they're entirely different beasts with target demographics that may overlap to some degree but are largely complementary.
Call me when Redbox goes online. No, scratch that -- call me when it goes online with a subscription model. Otherwise, it's just competing more with Apple and Amazon.
So what does it take, then?
Of course, Netflix is not bulletproof, and there must be some Kryptonite around here somewhere. Here's how I can see Netflix going down in the foreseeable future:
- Comcast throws caution to the wind and goes all-in with on-demand services. This won't happen because its legion of content providers would fight this move every step of the way, and the company hardly wants to antagonize all of it partners, suppliers, and customers at once.
- Apple abandons the per-rental model and sells subscription services through iTunes instead. This isn't likely because all of its digital licenses would have to be renegotiated (see Comcast, above), and Apple would get sucked into a lower-margin layer of the movie market. That's just not how Steve Jobs operates.
- Hulu and its backing consortium of Hollywood giants look beyond the TV episode market and make a grab for full-length movie domination. This is perhaps the most likely of all the threats, but Hulu still faces an uphill battle against 15 million paying Netflix subscribers and clashing agendas behind the hands that pull Hulu's strings.
The bottom line
Netflix is not cheap right now, but sometimes you get exactly what you pay for. There are lots of potential threats on the horizon, but no credible ones within striking distance. The stock could pull back a bit every now and then, but the long-term value of Netflix is nearly indisputable. And unless one or more of these rather unlikely downfall scenarios comes to pass, short-sellers will be left holding a very expensive bag.
Did I miss your favorite Rube Goldberg machine of Netflix destruction? Enlighten us all in the comments below.
