I'm a customer of Netflix (NFLX). I don't know why, but I am. There, now that I have stated the long story, let's move on to the latest short story.
A Cable Car Wedding
Reed Hastings would have us believe that Netflix can share wafer thin margins with cable companies in order to grow.
"There's no reason that doesn't make sense for Netflix, depending on the economics," Hastings said. "If we look at potential competitors, if we can share some of the margin with them and then they're making money because they are upselling us through their ecosystem, that's a good thing all around."
- Reed Hastings at the Morgan Stanley Technology, Media & Telecom Conference
This is nothing less than an admission that Netflix US Subscriber growth has peaked and is now headed for the trough. Whether or not it is a desired life preserver or just another off the cuff conference joke (anyone remember this stock goes to 1000?) remains to be seen. Notwithstanding, this is the beginning of the end and Reed called it himself. Netflix has spent far too much money chasing streaming content deals and finally creating content and time has run out. Rather than maintaining subscribers it would appear they are petering out and switching off, and that was before competition started coming to the game.
Put aside the sorry state of things over in Los Gatos, CA and consider if this marginal dream actually comes to pass. The following is a list of the top Multi System Operators [MSO] by subscriber count as of Sept 2011.
|1||Comcast Corporation (CCT)||22,360,000|
|3||Dish Network Corporation (DISH)||13,945,000|
|4||Time Warner Cable, Inc. (TWC)||12,109,000|
|5||Cox Communications, Inc.1||4,789,000|
|6||Charter Communications, Inc. (CHTR)||4,371,000|
|7||Verizon Communications, Inc. (VZ)||3,979,000|
|8||AT&T, Inc. (T)||3,583,000|
|9||Cablevision Systems Corporation (CVC)||3,264,000|
|10||Bright House Networks LLC1||2,109,000|
|12||Mediacom Communications Corporation (MCCC)||1,100,000|
|13||Insight Communications Company, Inc.||670,000|
|15||WideOpenWest Networks, LLC1||432,000|
|17||Atlantic Broadband Group, LLC||258,000|
|17||Knology Holdings (KNOL)||258,000|
|19||Armstrong Cable Services||242,000|
|20||Service Electric Cable TV Incorporated1||217,000|
|23||Blue Ridge Communications1||171,000|
|24||General Communications (GNCMA)||146,000|
1 contains estimates from SNL Kagan
If Netflix manages to nab a MSO or two and will add them as an option to its On Demand offerings, I will wager my money that it will be with Charter or one of the much smaller MSOs down the list. Why Charter? All of the MSOs ranked higher currently offer or have announced forthcoming TV Everywhere initiatives. Charter has been trying to win customers through their TV Everywhere initiative by allowing users to search for programming from Netflix, Hulu & Amazon (AMZN) to boost the meager offering they have started with. Also, if Charter takes advice from TiVo (TIVO) CEO Tom Rogers, they'll start serving Over-The-Top content from set top boxes. Ouch, Tom! Think about this for a second, if a gigantic 10% of Charter's subscriber base added Netflix that would be an additional growth of 437,100 subs for NFLX. After sharing already thin margins, let's call a spade a spade and say it's more like 216,550 added. Then we get defections, and Cable is not the same as web sign-up churn/freebies/trials. Netflix is going to get precisely one try (which is probably close to what the current model obtains, though you'd be hard pressed to find out from the current churn reporting scheme). Finally, subtract from that number those who leave for a competing MSO. These customers are back in the boat they were in before, they have Netflix, they left Netflix, or they are getting Netflix. They go back to net zero gain for our purposes.
For each major MSO the cost of helping Netflix grow at the expense of their own growth cannot be lost on a single one. Cord cutting is not yet all the rage but there is a reason everyone is working on TV Everywhere. Other than stragglers who can only afford the content licensing via Netflix for a tiny shaving of a tiny margin of profit, I doubt this will be much more than a short squeeze of news for a week or so sometime in Oct. or sooner. For any who do take Netflix up on this "offer," I imagine it will be the kiss of death, as they are slowly squeezed out of content markets by bigger and better money.
It is possible that Netflix survives this harsh climate of cost and competition. It is possible that they decide to love DVDs again (which actually made them money). It is possible that they change their business model another 4 times this year and amazingly squeeze the shorts. Nothing is impossible, but success is improbable at this late stage. The news that one can sign up for Netflix through Apple TV seems positive, but I believe we'll find additional cost associated with this buried somewhere in the next quarterly report. Unless it made no difference to subscriber numbers.
I plan on buying puts and strapping them with calls to generate more money for puts on the inevitable short squeezes to come. I'll detail my option strategy and results in a follow up article. Please leave your favorite NFLX short strategy in comments.