It isn't the Battle of Britain, but Netflix (Nasdaq: NFLX) has opened a second front in the video-streaming business.
The company, which launched its streaming service in the UK and Ireland at the beginning of the month, is challenging Amazon.com's (Nasdaq: AMZN) LoveFilm for British viewers. The Amazon subsidiary, which offers DVD-by-mail rental as well as streaming, announced that it reached 2 million members just weeks ago.
Across the pond
Based on reviews from a number of British websites, the early results seem to be a split decision. LoveFilm's Instant service is a pound cheaper per month than Netflix's, at 4.99 pounds compared with 5.99 pounds, but Netflix wins kudos for having easier setup, better picture quality, more compatibility with smartphone apps, and the ability to run on more devices. In the all-important battle for content, LoveFilm offers more movies, but Netflix is better for TV shows.
The difference, though, is that Netflix is just getting started across the pond. In his recent Q4 letter to shareholders, CEO Reed Hastings said that as his company's membership grows in those countries, it will be able to "invest more and more in content," thus testing LoveFilm's claim to better movie selection. Hastings sees competition from the Sky network and BBC's free iPlayer in addition to LoveFilm.
The incredible shrinking DVD
Netflix seems content to harvest its higher-margin DVD-by-mail service and is instead focusing on the streaming market. Currently, domestic DVD subscribers provide a contribution margin of 52.4%, compared with just 10.9% for domestic streaming, but Hastings has said that streaming subscribers are incrementally more valuable than their DVD counterparts. In Q4, DVD subscribers declined by almost 20%, down to 11.17 million from the previous quarter. International revenue for the quarter reached $29 million, but the company posted a contribution loss of $60 million in that segment.
Netflix's strategy appears to create an opportunity for Coinstar (Nasdaq: CSTR), owner of the Redbox DVD kiosks. Redbox has grown to be the market-share leader in DVD rentals, moving up to 37% in 2011 from 25% the year before, and Coinstar continues to put up impressive financial growth numbers as well. In its third quarter last year, revenue grew 22.5% to $465.6 million overall and 27.7% for its Redbox segment. Operating income shot up 42% to $65.6 million.
Those numbers would be great if the DVD-rental market wasn't shrinking. Research firm NPD group said that DVD and Blu-ray rentals dropped 11% in 2011. Despite the drop, DVD rentals are still more popular than streaming, with just 31% of movie rentals coming from streaming.
Foolish takeaway
Netflix critics claim its business model is unsustainable and don't see the company lasting more than a few years, especially with deep-pocketed rivals like Amazon and Apple in the ring. The company is making a big bet on international expansion, having invested heavily in content as its library assets are now valued at almost 6 times what they were a year ago. This will be a make-or-break year for the company, but its Q4 numbers are promising. Stay up to date on breaking news on Netflix by adding it to My Watchlist.
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