Netflix: Sell This Dog Now

| About: Netflix, Inc. (NFLX)

By Doug Ehrman

It is hard to imagine a more monumental fall from grace than the one that has been suffered by Netflix, Inc. (NASDAQ:NFLX) since the third quarter of 2011. Prior to that time, the company seemed nearly unstoppable. As a company, it was everyone's favorite up-and-comer, giving consumers a new and inexpensive way to enjoy home entertainment while still providing excellent service and expanding technology. As a stock, the chart looked more like a launch pad than a pictorial depiction of performance; the stock marched steadily from a per share price around $20 in early 2007 to an all-time high of $295.14 on July 4, 2011. Even the corrections along the way were minor, providing small buying opportunities to anyone paying careful attention. The biggest complaint of most investors prior to that top was that they had missed the next big thing.

Of course that is when everything started to fall apart. The company instituted a massive price increase that took effect on September 1, 2011, largely in response to the company's need to renegotiate several of its major contracts with content providers. For many customers, this resulted in a price increase of nearly 60%. Those customers expressed their displeasure by beginning to flee, and causing the company's CEO to publicly admit he had not handled the situation well. What followed was a bout of corporate mismanagement and complete bewilderment that one had to witness to believe. First, the company was spinning off the DVD side of the business and renaming it. Then it dawned on someone that nobody wanted to run multiple accounts for the same service. Then the name was remaining. Then video games were spinning off. Then, then, then, then… The only then that really matters is that the company started to hemorrhage customers and the stock's price imploded - Wall Street began to wonder if Netflix was not, in fact, a 2008 financial company instead of a perfectly conceived home entertainment company.

The Picture Today

In a recent article, one analyst commented that despite the company's problems, he or she continued to view Netflix as the "best of breed" in the industry. While that may be the case in the immediate term, it is not the whole story. Instead, it is important to look at the company's competitors and then consider the short, medium and longer-term view before investing in this stock.

As the above analyst points out, the only true competitor to Netflix currently is Blockbuster, which is owned by Dish Network (NASDAQ:DISH). Blockbuster continues to have a murky reputation with the public, as it has not been fully accepted in its new role. The advantage for Dish is that its direct competitors, Comcast Inc. (NASDAQ:CMCSA) and DIRECTV, Inc (DTV), both have reputations for terrible customer service. Comcast has recently rolled out expanded on-demand services, similar to those offered by Netflix, making it free for anyone with a high enough subscription level. The message here is that despite the company has set its sights on this segment - bad news for Netflix.

Additionally, late last week a partnership was announced between Verizon Communications Inc. (NYSE:VZ) and Redbox owner, Coinstar, Inc. (NASDAQ:CSTR). In Verizon's continuing effort to expand its home entertainment offerings, the company is looking to develop a product to compete directly with Netflix and Blockbuster. This is an important distinction between Verizon's push for TV Everywhere through its FIOS service. This service is meant to target the 39 million customers Redbox currently claims. This is actually something of a master stroke by each of these companies as each recognizes the future direction of the industry. Redbox has built a significant following due to its low-cost structure and convenience. This obvious long-term problem with this business model, however, is that as more and more content moves out of tangible media, like DVDs, the growth potential is limited. The company will find it difficult to grow without a clear view toward new technology. For Verizon, if the company can secure a loyal following through the new offering, it may be able to convert a growing number of customers to its TV Everywhere service as well. The future of the industry seems to be a one-stop shop for all of these products. With Comcast in the game, Verizon has the additional advantage of simply being an option that is not Comcast. This new partnership has the potential to have a long-term impact on the entertainment industry, but in the near-term it poses a very real threat to Netflix and Blockbuster.

The final competitors in the space are Amazon Inc. (NASDAQ:AMZN) and Hulu Plus, a joint venture between Fox Entertainment (NASDAQ:NWS), Disney (NYSE:DIS) and NBC Universal, a division of Comcast. While Amazon does not currently appear to be a major player, Comcast's joint approach through Hulu and Xfinity seem intriguing. How each of these stories plays out will have a deep impact on this industry and will have an influence on the prices of each stock.

Best in Show

The long and the short of this story is that while as of today, Netflix may be the "best in breed" in its industry, winning a dog show does not change the fact that a dog is a dog. As things currently stand, Netflix stands on the precipice of a future in which it may no longer be able to compete. As such, while the stock may have some near-term potential, its mid- and long-term prospects are not attractive. This is a stock that should be avoided. One should allow for the fact that though the stock may become a high-flier again at some point, on a risk adjusted basis, there are simply better options.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.