Netflix Will Eventually Sell Off Its DVD Business

Sep.16.11 | About: Netflix, Inc. (NFLX)

Netflix (NASDAQ:NFLX) can no longer hide the problems with its DVD business. I have been bearish on Netflix for some time now, and I still expect more downside. I have brought up my concerns about Netflix before.

Netflix is down about 27% from when I first wrote about it. This is a rapid drop within a short period of time, so I would not be surprised to see a relief rally. If you are short I would look to take at least some profits.

Netflix is in a transitional period from a DVD rental business to a streaming service. Ultimately, this is the best move for Netflix long-term, but I still see a rough road ahead. I expect the DVD side of the business to eventually be dissolved, sold or spun off. I do understand that the DVD business is profitable, but I expect that profit to decrease over time. We are starting to see signs of this, as the company has lost about 1 million subscribers.

Netflix is facing stiff competition from Redbox, which is starting to become an issue for Netflix. Coinstar's (CSTR) plan to expand Redbox will be the nail in the coffin for Netflix's DVD business. This is especially the case now that the company has actually made it easier for subscribers to drop the DVD service, since the pricing is no longer bundled with streaming.

The streaming business is going to be tough for Netflix as well. Netflix faces competition from free videos services and lower-priced subscription services that are available online. I expect Netflix to increase revenue as it expands into international markets, but my concern is if this edge will be sustainable for Netflix. Right now Netflix enjoys the advantage of having its mobile applications preloaded to new devices made by leading manufacturers. If this were to change, I expect Netflix to be at a disadvantage, considering its content costs versus other competitors.

I'm still bearish on Netflix, but I do expect a relief rally. I may turn bullish on Netflix at some point, but that depends on the execution of its streaming business. Margins are definitely higher in the streaming business, but I expect this to decrease as more competitors enter the market place.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in NFLX over the next 72 hours.