Is Netflix a House of Cards?

Netflix (NFLX -0.62%) has a a lot riding on the second season of "House of Cards."

Will it continue its successful foray into original programming? Or start to lose its momentum?

Even after the record-setting numbers released on January 22, lncluding 2.33 million (domestic) and 1.74 million (international) net new additions, a lot of smart investors still wonder how long its meteoric rise can continue, and if its growth is sustainable over the long haul?

Remember when you were young and built those houses out of playing cards, carefully, card-by-card until eventually, you got nervous, your hand jittered and the house of cards crumbled to the ground.

I wonder is that Netflix? Is it one misstep or investor perception from tumbling back to earth? It's hard to imagine any company earning a P/E ratio in the rarified air of the 220s.

Creating Original Programming
Sure, Netflix has had a string of successes, but do those successes warrant the current valuation?  

"House of Cards" was a risk and showed Netflix could do original programming, so did "Orange is the New Black." Both these and other originals will boost Netflix's margins. But is anyone ready to say it does originals better than HBO? Not me.

One or two great series, such as "House of Cards"  – which I loved and watched in about 3 days  – against years of home runs by Time Warner's (TWX) HBO, including two of my favorites, "The Wire" and "The Sopranos," and most recently "Broadcast News." 

Increasing subscriber base
Of course, it's not just about original programming, but delivery of the programming or any programming by VOD and SVOD. There's no doubt, at the moment, Netflix is the king of SVOD with 44 million total and over 30 million paying domestic subscribers. It exceeded expectations, by adding 2.33 million domestic subscribers in Q4 of 2013. This on the heels of a respectable 1.33 million added in Q3 and a disappointing 630,000 in Q2. Netflix also added 1.74 million International subscribers in Q4 of 2013, but it's still losing money overseas even though the contribution margin is improving. 

Amazon.com's (AMZN -1.11%) Prime is estimated to have around $10 million subscribers, but Amazon does not release the exact numbers. Not all of the Prime members use the VOD service either. Hulu grew their domestic subscriber base from 3 million in 2012 to 5 million in 2013 according to the most recent numbers. And they hit the one billion revenue mark in 2013.

The Digitalsmith "Q3 2013 Video Discovery Report," showed that 41.7% of consumers get their SVOD from Netflix, while Amazon Prime has 12.7% of the market, Hulu has 9.4% of the market, and newcomer Redbox Instant, run by both Outerwall (OUTR) and Verizon (VZ 0.03%) earned 2%.

In terms of percent, Netflix has increased their base by 33% over the past year, while Hulu has jumped up by 67%. But for Netflix to justify its current value and keep growing at a pace that rewards investors, its share of the market needs to be monopolistic  – googlish. Google has 67.3% of the search engine market. 

Formidable competitors
It's hard, if not impossible, to see that happen since Netflix faces strong competitors that are adding subscribers and growing revenue. Not to mention the huge resources Amazon has at their disposal to grow Prime.

And new entrants to the market like Redbox Instant and YouTube premium channels, backed by Google, should continue to grow. Plus, other up-and-comers are likely to show up since the barriers to entry in the SVOD market are much lower than those in traditional media.

When you look at Netflix and their competitors, other companies have more room to grow. Netflix has hit their ceiling, at least in terms of their current competitive advantages. A world-changing innovation could change that. But for now it is left trying to grow its paid subscriber base by fending off the competition.

Time to move on
Common sense and historic precedent suggest it is time to look elsewhere. If you enjoyed the recent run up, thank your lucky stars, but consider moving on to less risky companies, ones on the cusp of sustainable long-term growth and not just off a euphoric ascent.

Netflix is not a bad company, but unfortunately it is a victim of its own success. It flew too high, too fast. Now its wings are about to melt. When the dust settles, and its valuation falls back to earth, it may make sense to get back in.

But for now, you'd be better served to take your cards before the house falls.