Netflix Drops As Competition Grows

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

Netflix (NASDAQ:NFLX) shares took a beating on Tuesday, dropping 6.35% and closing under $56 for the first time in a month. At Tuesday's low of $53.13, shares were down more than 11% and just 32 cents above their 52-week low. What was the culprit? Well, a major competitor of Netflix strengthened their position in the space, which got the major headlines. If you combine this with last week's big news, the Netflix punching bag continues to be whacked, leading to a $10 drop in shares over the past 10 days. Let's look at what happened.

Competition grows even more:

The big news of the day was that Amazon (NASDAQ:AMZN) has struck a deal with Epix for the right to stream about 2,000 movies, including recent blockbusters like "The Avengers" and "The Hunger Games". Netflix had an exclusivity deal with Epix, but that deal ran out in August, and Netflix decided not to renegotiate. Netflix still has access to Epix movies for another year, at which time they will have to strike a new deal to keep showing this content.

According to Amazon, its Prime unit will now provide access to over 25,000 titles, which is double what it had about this time last year when it launched its Kindle Fire tablet. Amazon is expected to launch its new version of the Kindle Fire this week, and adding Epix content to that device will be beneficial for the company. Netflix doesn't disclose its number of titles, but estimates say the number is over 60,000. Yes, Amazon has less than half of that, but Prime is growing.

According to reports, Netflix had been paying about $200 million for the Epix content, including the exclusivity rights. Netflix is trying to cut content costs, but to what degree remains to be seen. One analyst in the above mentioned article states that Netflix will save $50 million annually by losing the exclusivity rights, but another analyst says the savings will be only $20 million. Even if you take the midpoint of that, Netflix is only looking to save about $3 million per month, or $9 million per quarter. Given current revenue forecasts for the future, that will improve gross margins by about 75 to 100 basis points over the next year, but given all of the company's other costs, it probably won't move the needle that much. Remember, Netflix has about $4.5 billion in content licensing deals over the next 3 years, so they are looking to trim some costs. The company already ditched Starz as they decided the cost just was not worth a new deal.

Last week's news:

With the Labor Day Holiday weekend in the US, some investors might have missed the news out late last week. Time Warner's (NYSE:TWX) HBO announced it would be launching its own streaming service in the Nordic region. This move will allow consumers to get access to content, without having to have a pay-TV subscription. Like Netflix, HBO's service will be available in Sweden, Norway, Denmark, and Finland.

This will be a huge issue for Netflix, who recently announced it would be launching its streaming service in those four countries. The real problem is that HBO will launch its service in October, while Netflix is scheduled to launch "by the end of the year". Now, I recently called Netflix's move into these countries "not a big one", but the HBO move makes Netflix's move even less important. Netflix is entering another competitive environment, where it will have a tough time grabbing subscribers, and increased costs will probably occur. Netflix is probably working on revising downward their international subscriber forecasts for Q4 of this year and for 2013, as they will now be the 2nd to launch in this region.

Conclusion - More shots at Netflix:

Netflix investors looking for good news are going to be searching for some for quite a while. The Amazon news bolsters its Prime video service, creating a stronger competitor that Netflix continues to shrug off. The HBO news will take a chunk out of Netflix's international expansion plans, which were questionable to begin with.

It's very hard for some investors to short Netflix at these levels, since the stock is down about $25 since its last earnings report. While it is possible that this news could help push the stock to new 52-week lows (which we almost saw Tuesday), there isn't a ton of downside left in my opinion until we get another earnings report. Netflix shares have already dropped $10, meaning if you haven't been short lately, you've missed the real move. I continue to recommend shorting this name on pops, so I hope investors listened on the latest run to $65. It didn't last for long, and Netflix's dominance in the streaming space is dwindling by the week.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.