Netflix Could Sink $40 By 2014

| About: Netflix, Inc. (NFLX)

By Veronica Chang

Netflix (NASDAQ:NFLX), the leader in digital video rentals and online video streaming, is facing stiff competition in its core video streaming and physical video rental markets, even as its attempts to manage its high-profile push into markets outside the United States.

Verizon (NYSE:VZ) recently announced that it was partnering with Coinstar's (NASDAQ:CSTR) Redbox launching a competing streaming video service. Verizon is only the latest is a string of high-profile competitors keen on taking market share away from Netflix.

Meanwhile, Amazon (NASDAQ:AMZN) and Viacom (NYSE:VIA) have also partnered to launch a similar service, while Comcast (NYSE:CCS) has introduced Xfinity Streampix. Even recently listed social network Facebook (NASDAQ:FB) is hoping to leverage access to its immense user base to compete with FindWatchShare. Not to be outdone, Apple (NASDAQ:AAPL) is said to be developing its own streaming service that will use Apple TV and iTunes as its delivery channel.

Netflix currently holds 55% of the online video rental market, which is down from its peak market share of nearly 60%. Facebook's potential threat notwithstanding, Amazon is clearly its biggest threat at this time.

Specifically, Amazon's deal with Viacom is only one of the ways through which it is competing with Netflix, even co-opting Netflix's distribution channels like Sony's (NYSE:SNE) PS3 Media Console to give its Amazon Prime customers access to streaming video. With as many as 5 million Amazon Prime subscribers, Amazon may already have as much as 12% of the streaming video market.

What's more, Amazon has the advantage of leveraging its Amazon Web Services cloud computing service to scale up quickly when demand rises - whereas even incumbents like Netflix have to rely on outsourced services to meet bandwidth pressures.

That said, Verizon's deal with Redbox is similarly potent; Redbox already leads the market for physical disc rental, edging second-place Netflix 37% to 30%. Its Kiosk rentals surged 30% in the 1st Quarter of 2012, when Home Video spending grew by 2.5% overall. Coupled with Verizon's high-speed 4G/LTE network, its streaming service could find a strong perch among Tablet users.

That competitors are circling the waters is a grievous self-inflicted wound that Netflix will have to overcome. Specifically, Netflix's troubles began in the 3rd Quarter of 2011 when it launched its failed Qwikster service that promptly fragmented the company's product offering and alienated loyal customers.

At the same time, its failure to renew its deal with Starz to air original content hurt it as it weakened Netflix in Television Streaming, which now accounts for over half of its viewing traffic - likely to the benefit of competitors such as Hulu which, like Amazon, challenge Netflix on its various distribution channels such as Smartphones and Game Consoles.

Interestingly, Netflix may have an opportunity to replenish its original content portfolio through the summer cancellations of the major networks. Netflix is purportedly in discussions to resurrect cancelled television programs like CBS's (NYSE:CBS) Jericho and Fox's Terra Nova. The rationale behind the move is that Netflix, unlike the large U.S. Networks, has data on consumers' viewing habits that will enable it to determine which shows have a chance of succeeding online.

Despite the stiff competition it faces in the U.S. Market, Netflix's biggest financial flashpoint may be its foray into United Kingdom and Ireland, which is expected to take a significant bite out of its cash flow. What's more, Netflix faces heady competition in those markets from local incumbents such as BSkyB.

Netflix's investments in the U.K. and Ireland are on top of its spending in Canada and Latin America, which it entered in 2010 and 2011. All told, Netflix lost over $100 million in those markets in the 1st quarter of 2012, although it has indicated that its Canadian operations would provide a positive contribution to profits by the 3rd quarter.

Given that Netflix entered Canada in the fall of 2010 and will only turn a profit by the 3rd quarter of 2012, it's reasonable to assume that it will take two years for its British and Irish operations to turn a profit.

On present trends, that could mean cumulative losses of between $500 to $800 million from its overseas operations through 2014 - meaning that for the overall entity to register earnings, Netflix will have to retain its current market share and hope that the combination of an expanding market - its industry is expected to grow 63% in 2012 and nearly 30% in 2013 - and higher fees (unlikely given its experience with Qwikster) will sustain it in the interim.


Netflix is clearly a stock market darling that has fallen on rough times; from a high of almost $300 prior to its unwise decision to launch Qwikster and revise it pricing structure, its stock has fallen by 75% - with no signs of a serious let-up.

Indeed, the only thing that investors in Netflix can hope to see is continued losses.

In the final analysis, Netflix is a company lacking a solid growth strategy - its expansion overseas, while commendable, is foolhardy as it comes at a time when it faces very stiff and multiple competition on its home turf. In fact, rather than halting its overseas expansion to the British Isles amidst the Qwikster debacle, it decided to go ahead - at a potential cost of $800 million over the next two years.

Meanwhile, it has nothing to rely to prevent its competitors such as Amazon, Verizon, Comcast and Time Warner - or even Apple or Facebook - from poaching its customers. Any and all of these companies could find a way to deliver half or all of the content that Netflix presently delivers online. That went down the drain the moment Netflix failed to sign a deal with Starz.

Beyond all this and purely from a market perspective, Netflix remains an expensive stock. Its Price-Earnings (P/E) ratio of 24 is higher than the S&P500's 21 and the NASDAQ-100's 10.5 - even though its own performance has trailed the S&P500's by 1% and the NASDAQ-100's by over 8%.

Consequently, I see Netflix's share price falling even further, to as low as $30 in the next 15 months.

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