Netflix, Open Table: The Perils of Not Owning Content

Includes: CBS, DRI, NFLX, OPEN
by: BubbleBustInvesting

Open Table (OPEN) and Netflix (NFLX) have been the poster children of web-based businesses that captured and captivated the minds and the wallets of the momentum crowd that chased after their stocks. For more than a year, the stocks of both companies reached for heaven but couldn’t get there. So they have been falling back to earth, though Open Table has been falling at a faster pace, especially after Tuesday’s disappointing report that sent the stock sharply lower in the after market hours. Does it mean that Netflix will share the same faith with Open Table?

To answer this question, let’s go over a quick strategy lesson: What do Open Table, Netflix, Durden Restaurants (DRI), and CBS Corporation (CBS) have in common? Let’s take Open Table and Netflix first. They do not have any production facilities, but they do have a site where they sell somebody else stuff. Open Table sells reservations for restaurants it doesn’t own. Netflix sells movie content developed by movie studios which it doesn’t own, ether.

Now let’s look at CBS and Durden restaurants. They both have their own facilities where they produce their own stuff. CBS has its own studios that produce content. Durden Restaurants has a portfolio of restaurant chains that serve food to customers.

Next, let’s look at the relationship between the two groups. CBS is a supplier of content to Netflix. Durden Restaurants is a supplier of reservations to Open Table. Here comes the crucial question: When the two pairs of companies negotiate, which side has the upper hand? Obviously, CBS and Durden, as both companies have a variety of options: They can sell their stuff (CBS content, Darden Restaurants reservations) directly to customers or they can auction their stuff to the highest bidder, allowing each to earn what economists call “normal profit,” an average rate of return; CBS' robust profit report Tuesday afternoon confirms this point.

But the momentum crowd doesn’t seem to get this lesson right; it keeps on chasing after the wrong stocks, as is confirmed in the chart below. Although it makes a great deal of money on the way up, it ends up losing it on the way down, and then some.

[Click to enlarge]

Open Table and Netflix do not have a sustainable competitive advantage, because they have no barriers of entry to protect their businesses from competition and because they don’t have bargaining power to get favorable prices for the stuff they buy from suppliers. CBS and Darden Restaurants are better long-term investments than Open Table and Netflix.

Disclosure: I am short NFLX.