1 Way Netflix Can Halt Its Death Spiral

| About: Netflix, Inc. (NFLX)

I grew up on the border between Niagara Falls, New York, USA and Niagara Falls, Ontario, Canada. I actually lived on the American side, about 10-15 minutes from "God's Country," but you get the point.

As a kid, I always remember family and friends poking fun at Canadians. As I grew older, and spent loads of time in my third favorite city, Toronto, I started to realize that many Americans have an inferiority complex when it comes to Canada. Canadians understand this, which is why they often tend to downplay any perceived rivalry of wits between the two nations.

I also recall Rick Mercer driving that point home on his CBC show, The Rick Mercer Report, during a segment called Talking to Americans:

I have always believed that America can learn quite a bit from Canada. In business, I have argued for months that "we" must learn from what's happening in Canada in telecommunications, media, sports and entertainment as it pertains to Rogers Communications (RCI) and Bell Canada (BCE). You can review my articles on both companies for more color.

It's comical that cats like Bill O'Reilly can refer to Canada as "socialist" when the apparently "capitalist" United States will not even allow AT&T (T) to take over T-Mobile. The socially liberal side of me cringes when I think of the empires Rogers and Bell are building in Canada, but, as an investor, I love it. Allow me to digress and explain what any of this has to do with Netflix (NFLX).

I am not long RCI and BCE simply because they have a foothold on practically everything that matters to an entire nation. It has quite a bit to do with both companies' innovative ways. They're moving to secure premium content and brands and leverage them via a multi-platform delivery system. Like Netflix CEO Reed Hastings, Rogers and Bell see the future. Both companies continue to make all the right moves.

Consider the latest from Rogers via The Globe and Mail:

Canadian supermodel Coco Rocha makes her debut as the host of Canada's Best Beauty Talent on Sunday night. But you won't be able to watch highly produced, high-definition reality television show on a traditional television network.

The 12-part series - which pits makeup and hair specialists from across the country against each other in a series of competitions intended to crown one contestant the most skilled of them all - is being filmed by Rogers Media Inc. exclusively for broadcast to the Internet, and is funded directly by an advertiser.

It's a novel and potentially profitable approach to reality-television programming that the broadcaster is counting on to drive viewership higher, even as more Canadians cut their cable subscriptions in favour of cheaper online alternatives ...

And while vertically integrated companies such as Rogers ... which not only create their own content, but also own the distribution networks used to get them to viewers - are forced by regulators to share most programming with competitors (for a fee), anything produced exclusively for online use need not be shared ...

L'Oreal contends overall viewing numbers don't really matter - what does matter is the precise targeting of its advertising dollars.

That's one reason why I am so bullish Pandora (P). They can take content that they do not even own - and arguably "overpay" for - and make it valuable in their own novel way. Advertisers will continue to flock to Pandora because of exactly what L'Oreal (OTCPK:LRLCF) said - "precise targeting." Netflix can do this as well.

I am not sure why Netflix has not, at least on a trial or case-by-case basis, turned to advertising. I have an email into the company asking about one potential reason why. It makes logical sense that content owners who license programming to Netflix would prohibit the company from monetizing it through the use of advertising. I am not sure if that's the case, but, if it is, it provides one explanation why Netflix has not gone what I consider the obvious route. If these rules do apply in arrangements with outside parties, they certainly do not come into play when Netflix does original programming.

As I continue to explain, because Hastings has sentenced the high-margin and profitable DVD business to death and subscriber growth as effectively stalled, Netflix desperately needs another source of revenue to fuel its streaming ambitions. It cannot keep going to market asking for $200 million a pop.

Nothing should stand in the way of the company securing advertisers to pay for and/or provide a new revenue stream by sponsoring original programming like L' Oreal is for Rogers. And, if Netflix cannot sell at least some ad space on the rest of the digital content it licenses, it has even worse deals with the programmers and studios than I thought. At the very least, Netflix should go back to the bargaining table and offer a cut of all advertising revenue to the content owner.

This type of model could look a lot like what Rogers is doing and what Pandora will soon be known for throughout radio, if it is not already. Netflix should have data on its users, ranging from age and location to entertainment preferences. If Pandora can monetize that knowledge, I am not sure why Netflix cannot.

If some sort of contractual hitch stops the company from doing so that's one (really unfortunate) thing. But, given Hastings' knack for seeing the future, I do not think it has anything to do with lack of foresight.

Disclosure: I am long BCE, P, RCI. I am short NFLX via a long position in NFLX put options.