As I've noted in several previous articles, Netflix (NFLX) is in trouble. If you're unfamiliar with the history or just not one to look too far into the numbers, it would be easy to think that all is well again at the company, as the stock is back up over a hundred dollars per share and subscriber growth picked up again last quarter. Be advised: all is not well.
As I noted before, Netflix faces at least three new deep-pocketed competitors in the streaming business: Verizon/Coinstar (VZ), Comcast (CMCSA), and now Intel (INTC). Those who argue that Netflix's status as the first one to the streaming party will make it difficult for newbies to catch up are missing the point. The worry is that Verizon and Comcast will begin bidding for content licenses and drive-up the prices Netflix must pay, thereby squeezing the company's already paper-thin streaming margins.
Of course, the company's major problem (and something that Netflix shareholders try to talk their way around) is the fact that, thanks to a transition away from its high-margin DVD-by-mail service, the company is expected to lose money in 2012. Put simply, if last quarter's results are any indication, streaming is a money-losing enterprise. Counting its international business, Netflix lost nearly $8 million on its streaming business in the fourth quarter.
Apparently however, Netflix doesn't believe there are enough hurdles to jump in the coming year as, according to the Wall Street Journal, the company is considering partnering with cable TV operators to "offer its content alongside other pay-television channels." The obvious concern is that
"Netflix's $7.99-a-month fee for streaming content doesn't appear very profitable...[and] margins would be squeezed [further] by a deal in which Netflix shared some of that fee."
An added concern is that the company would likely be forced to pay new licensing fees to studios in order to get clearance to stream the content directly to consumers' televisions. The company can ill-afford to go that route as it already "has $3.9 billion in streaming-content obligations, the vast majority of which are due in the next three years."
Another concern is regarding cash flow, Netflix seems to be taking a page out of Groupon's (GRPN) book as the Journal notes that although the company's cash flow was $187 million last year, that number "would have been deeply negative were it not for delayed payments to studios," as indicated by a 500% increase in [content] accounts payable from 2010 to 2011. It's also worth noting that 'other accounts payable' rose 62% during the year.
Backing-up the contention that the company is running out of cash is Netflix's November announcement regarding the issuance of $200 million in convertible bonds-- as CNN notes, secondary offerings "can signal that expenditures have outpaced expectations and that a company needs to raise more cash." That issuance was just a portion of a larger plan to raise $400 million.
In any case, the fact that Netflix is considering partnering with cable TV operators is further evidence that the company just doesn't get it: Netflix simply cannot afford any further erosion of its margins. I now see virtually no reason to own shares of Netflix as I firmly believe, in the long-run, it will be completely run out of the market by competitors with more money and other businesses, which will act as buffers against the low margins associated with streaming. I'm not alone in this contention. The last line of the aforementioned Wall Street Journal article reads: "...investors should pull the plug" on Netflix. I'd recommend either shorting Netflix or buying puts.