Seeking Alpha
Independent research, bonds, long/short equity, macro
Profile| Send Message| ()  


The stock price of Netflix Inc. (NFLX) has plunged 61% to its lowest level since the high of $298.70 reached on July 13 for a myriad of reasons. (See Chart Below, click to enlarge)

Chart Source: Yahoo Finance

First, there was this separating streaming from DVD in July with the untimely hiking its subscription prices by as much as 60%+, in the middle of a 9%+ U.S. unemployment rate, diminishing middle class income, and mounting worries of a global double dip recession. The resulting backlash from customers has been significant enough that in mid September, the company cut its third-quarter forecast by 1 million U.S. subscribers, sending its shares down nearly 19% on the day.

Netflix tried to salvage the situation via a blog post by its CEO and co-founder Reed Hastings openly apologizing that "I messed up and owe everyone an explanation". However, the so-called apology blog lacks substance, and the damage has already done. According to Reuters:

Subscribers didn’t shy away from letting Hastings hear their displeasure, weighing in on the company’s blog with over 15,200 comments, the bulk of them overwhelmingly negative.

We think to some Netflix subscribers, the separation of DVD and streaming, and the rate increase are somewhat (barely) tolerable considering none of the others like Blockbuster (OTC:BLOAQ) or Amazon (AMZN) can match Netflix streaming content library at the moment. However, even with that advantage over rival services, Netflix streaming library still pales in comparison to the DVD selections, as many popular (new and classic) movies are only available in the disc format.

Blockbuster, meanwhile, boasts a similarly vast DVD library with movie studio deals to get many new DVD releases 28 days before Netflix to boot. So until Netflix's streaming library comes close to the depth of DVD's, it is presumptuous as well as arrogant on the part of Netflix management to think customers would automatically flock to the streaming service of Netflix simply due to its new pricing structure.

Then the last straw came when Netflix decided to spin off the DVD business into a separate company called Quikster, which means subscribers will need to manage their queues on two different web sites. This not only further infuriated Netflix subscribers, it also left analysts at a loss. We get the symbolic significance of setting the company apart from the brick and mortar DVD operation. Nevertheless, we fail to see a real business case for a DVD unit operating under a different name and web site that'd serve only to further alienate the current DVD subscriber base of about 14 million.

This "Quikster move" not only seems to suggest a message that Netflix does not value DVD customers, but also looks like at least in part another concerted effort by Netflix to "encourage" customers to the streaming service which the company sees as the future.

From a strategy execution standpoint, there are many other, much more subtle marketing, promotional and phased-in price increase tactics one could use to achieve the same goal of migrating subscribers without looking like a bully. In the end, that kind of strong-arm "migration" approach would only lead to more subscriber losses while giving Blockbuster the perfect opportunity to have its "revenge campaign" after basically being driven into bankruptcy by Netflix.

Moreover, we also believe Netflix appears to have overestimated its branding power and customer loyalty. After all, Netflix is no Apple which has carved out a niche within the consumer digital products sector with high branding and an ecosystem to foster customer loyalty or just for the hip factor.

But the entertainment content business is fairly generic, where consumers essentially look for the best service and price combination. Netflix used to be the leader in that combo of service and pricing, but it has now lost that differentiation which has made the company successful in the first place, and it'd be just a matter of time before Amazon, Microsoft (MSFT), or Apple (AAPL) would come up with a superior offer to completely replace Netflix.

Last but not least, there are multiple headwinds from increasing costs and rivals suggesting this is not yet the end of the stock price tumble.

On the cost structure side, Netflix is under pressure from Hollywood studios and pay TV rivals, not to mention cable companies no doubt are looking to end Netlix's free ride on their high-capital-cost broadband network.

On the competitive front, rivals Amazon.com (AMZN) and Microsoft Corp. (MSFT) have already unveiled competing products. Amazon has its own video stream service to work with its new Kindle Fire tablet, while Microsoft plans to offer online pay television service from Comcast Corp. (CMCSA) and Verizon (VZ) through its Xbox Live streaming service.

The hottest speculation right now is that by launching Kindle Fire, Amazon looks set to acquire Netflix. If a deal could be reached for Amazon to acquire Netflix, Amazon would instantly become the sector's leader, and Netflix stocks could get a bump as a result. Otherwise, there do not seem to be many near-term catalysts to bring Netflix stock back into the swing of things.

In the past year or so, we have repeatedly warned investors, even when the stock was killing all the shorts and seemingly unstoppable, to take profits off the table when possible, and identified Netflix as one of the five stocks due for a pullback in 2011. And this recent bungle and arrogance of Netflix's management, as discussed herein, has also left us to question the company executive's leadership and management capability.

So the bottom line is that we have not seen much to alter our view that Netflix is a pure momentum stock with a not-so-differentiable business model in the über competitive tech and digital entertainment sector. When the stock's momentum is lost--as it is now--look out below.

Source: Netflix: What Not To Wear At The High Stake Tech Party