In 2011, I, along with many others, was a major Netflix (NFLX) bear. While I didn't capitalize on it fully, the continued antics of the NFLX management team provided the bears with ample helpings of fresh meat. My bearishness has continued into 2012 and will likely remain for the rest of the year.
2013 is a whole 'nother animal. My thesis begins and ends with content.
What a Customer Wants
Content is king. Luckily for Netflix, it is currently top dog in streaming content, with a much broader selection than any of its competitors. The problem is that right now and for the last few months this content has stagnated and that doesn't appear to be changing for another six months.
For the remainder of 2012, Netflix has announced the following additions to its domestic streaming service: Kevin Spacey Original Series House of Cards scheduled for late 2012 release. Okay, one new show, likely released all at once like Lillyhammer. How about new movies? Nada. Zip. Nothing.
If I can start to feel tired with the content currently available inside my free month, how exactly is Netflix going to be able to grow or even maintain its customer base for the rest of the year with one new show and nothing else for six months. At the rate people go through content, six months is an eternity without fresh input.
Add in the fact that Netflix is already experiencing budget issues with the production of House of Cards and we may end the final six months of the year with no new content arriving. Anyone predicting massive customer gains without also recognizing that the static content schedule for 2012 will cause increased churn is sticking their head in the sand.
Customers can and will seek out new content. To not have any new content in the pipeline for 2012, while expecting large domestic customer gains does not compute.
The year 2012 could easily see a much lower print on NFLX stock. Disappointing domestic subscriber growth due to a stagnant content offering will incite harsh punishment from the investing public. NFLX does not trade on top or bottom line growth, it's all about subscriber growth with a heavy emphasis on domestic adds. No new content in 2012 could have its main trading metric sending warning signs galore.
While I predict a fairly bleak 2012, I suggest that 2013 could be a strong turnaround for the company due to the new content deals coming on line.
Already announced for the 2013 content additions, we have:
- Dreamworks New movies and Catalogue titles to begin in 2013
- The Weinstien Company in 2013 brings in The Artist and The Iron Lady
- Arrested Development is slotted for a 2013 release
- Original Series Hemlock Grove to be released in 2013
- Original Series Orange is the New Black to be released in 2013
So three new series and two small, but critically acclaimed, movie studios with the potential for more additions to be announced in 2012. Not a bad start by any means.
Along with the additions, we should not see the removal of any content. There is always the possibility that some of the existing contracts have the same built-in poison pill as Sony/Starz, but as it stands now, Netflix should be able to keep the content it already have through 2013 at least.
The year 2013 has enough new content to attract many that may churn through 2012 and that could make domestic subscriber adds surge after a string of disappointments.
An Aside on Original Programming and Rentals
One thing that I simply don't understand about the NFLX management is its handling of original programming. Starting with Lillyhammer and continuing with Arrested Development, House of Cards and presumably all of the other original series it is releasing, for some reason Netflix is releasing them all at once instead of spacing them out on a weekly basis.
Serial television is serial for a reason. To maximize your return on the subscription service the content should be spread out over time. Simply by spreading out a 10 episode series over 10 weeks, you are turning interested free month using customers into revenue contributing at least 2 months of subscription fees. Sure, that depends on customers liking the series enough to watch it each week, but even if they hate it, you are no worse off by spacing it out over time.
If Hastings has some idyllic notion (he probably does) that customers hate serial television and deserve to have it all at once, he obviously has forgotten that he is running a business. The minor benefits of allowing the customer to gorge themselves in a free month versus the significant benefit of putting money in the company's pockets by spacing it out on a weekly basis should be an obvious choice.
Another obvious move would be to offer digital rentals and digital sales of first run content. Sure, you are competing vs. Wal-Mart (WMT), Amazon (AMZN), Apple (AAPL) and a ton of others, but Netflix already has a 26M user base that would see this as additional value of the service. Right now, Netflix is not capturing anywhere near the true potential of its user base. Offering rentals and purchases is not a downside, it's pure benefit for the customer. Just about the only downside I can see is that it would remind the customer of the limited free streaming selection and potentially cause higher churn.
Why the company has not made these moves, I can't say. It could be due to the nature of its current content contracts. It could be pure hubris from Hastings and Co, thinking that they know what is best for the customer.
Using the price increase and Qwikster decisions as a backdrop, the hubris angle gains a lot of traction.
As Always, What is the Trade?
I stand by my recent call to buy NFLX on weakness using a move from green to red to green intraday as the signal.
Anyone that followed and bought weekly calls on such a move on Wednesday, May 23, and Friday, May 25, would have got significant returns. Set a 5% stop loss (or whatever your risk management principles indicate) and let it run. NFLX has a tendency to run $1-$3 up on such moves. Once the uptrend is established move your stop up until you are stopped out, hopefully at a profit.
I no longer believe that NFLX is a safe interday hold and would avoid the name for 2012. A short position could be justified, but we have Mark Zuckerburg running around the market now with a brand new pile of cash and no one able to say boo about what he buys. I would not put it past him to go after NFLX for the user base and content deals.
If 2012 has no buyouts materialize, I plan on watching the price action in front of Q4 earnings in January 2013. If expectations are low enough, we could see a repeat of last Q4 earnings, with strong Q1 and 2013 projected domestic adds causing a short squeeze in the shares. Unlike 1Q2012, I feel that we could see additional strength forecast through 2013.
While a bounce-back in 2013 for NFLX is definitely not a sure thing, the additional content coming online should definitely help its main reporting metric of domestic customer additions.