Netflix's Perfect Blunder?

Jun. 5.12 | About: Netflix, Inc. (NFLX)

Eleven months ago Netflix (NASDAQ:NFLX) was on the verge of becoming a $300 a share stock, a milestone Apple (NASDAQ:AAPL) was striving for at that time. While Apple reached its peak at nearly $630 a share and is still valued in the upper $500 range, Netflix has plummeted to $62 a share. A lot can happen in eleven months. What is so tragic about Netflix's fall from grace is that it was entirely their doing. If an analyst wrote a script on how to drive Netflix customers away, I expect it would look exactly like what happened from July to September in 2011.

Netflix and Coinstar's (CSTR) Redbox had already sent Blockbuster into Bankruptcy proceedings and Netflix was still light years ahead of every would-be competitor in the streaming video market both in technology and content. Customer satisfaction was sky high, subscriber numbers were over 23 million and climbing and then it happened. In July of 2011, Reed Hastings, CEO of Netflix, announced that as of September 1st, 2011 Netflix was going split the streaming and DVD delivery services and charge a separate fee for each that equated to a 60% price hike. Public outrage erupted immediately. The Facebook (NASDAQ:FB) post in which Netflix announced the price change received over 28,000 comments many of which were customers threatening to cancel their subscriptions.

The public relations nightmare was renewed shortly after the rate hike when in a textbook example of terrible timing, Netflix announced that it was spinning off its DVD delivery service under a new name, Qwikster. This would mean to manage the streaming and DVD services the customer would need to have two logins for two separate websites making the services less user friendly. The internet exploded with renewed outrage which prompted Netflix to abandon the effort but the damage was done. Many of Netflix's customers and investors had lost confidence in the company. When the dust settled around 800,000 subscribers canceled their subscription and the stock price had lost over 30% within a few months' time.

It is astonishing that a company that had done everything right for so long suddenly lost its way. There wasn't a change in leadership or any other perceptible cause that I could find. In light of the absence of a reasonable explanation I decided to consider the unreasonable and inexplicable; temporary insanity, alien abduction, conspiracy. I considered my own experience as a Netflix subscriber and how it changed during that time period. I examined my choice to cancel the DVD delivery portion of my subscription and keep the streaming video. I was paying about the same amount for half of the service and I was pleased with the product. There had been rumblings of Netflix trying to migrate their consumers away from DVD delivery to streaming for some time due to the cost of shipping, handling and storage of the DVDs.

Conspiracy, something about that stuck in my mind and I just could not shake it free. Could this perfect blunder have been by design? If so, I am sure that even Reed Hastings would admit that the fallout was far greater than anticipated but over the long term this may very well be the best thing for Netflix. Subscribers seem to be returning, in fact, Netflix estimates that one third of their "new subscribers" are actually returning subscribers. Some, like me, may have sampled the competition and found that Netflix, despite the fee hike and Qwikster debacle still have the best movie/TV streaming product, others have cooled off and are willing to forgive and forget.

So where does that leave Netflix now? Their stock price is dropped from $298 a share to $62. They still have a commanding lead in both technology and content from the growing field of competitors. The customers that originally left in righteous anger are returning and Netflix has increased the profit margin for those subscriptions by not giving in to the customer outrage about their rate hike. A recent customer satisfaction survey shows that Netflix has customers are satisfied yet again. Perhaps this obvious blunder was a calculated but bold strategy to improve the future of the company. One of the paramount concerns for Netflix bears has always been the ever increasing cost of content and the pressure it causes to Netflix margins. Perfect blunder? In retrospect, perhaps Reed Hastings deserves a bit more credit for making a few hard decisions that will, in the long run, truly benefit Netflix and the customers.

If that is the case then Netflix appears to be significantly undervalued. It may take some time for the market to realize it so I would put this on your watch list and wait for some positive momentum. This stock price could double by the end of the year.

Disclosure: I am long NFLX, AMZN.