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Amazon (NASDAQ:AMZN) announced yesterday that it secured a deal with Epix, dealing a significant blow to rival Netflix (NASDAQ:NFLX). Epix is the content provider co-owned by Viacom (NASDAQ:VIA), Lions Gate (NYSE:LGF), and MGM, which grants it rights to blockbuster content such as The Avengers and The Hunger Games. Netflix hit its 52-week low in late July and I urged you to sell for three reasons:

  • International Continues To Drag Profits; DVD Cash Cow On Last Legs
  • Management Does Not Inspire Confidence
  • Exclusive Content Is Important, Until We Lose It

The third reason is growing stronger with Amazon now offering a very similar content library at a lower cost. Amazon quietly entered the streaming business in 2006 with Amazon Unbox but did not seriously enter the space until 2011 when it bundled its streaming offering with Amazon Prime. Amazon Prime allows consumers to pay a low annual fee ($79) in exchange for free two day shipping on purchases. Amazon has been successfully following a land grab business model in which it is sacrificing current profitability in order to seriously harm its competitors in the long-term. For example, Amazon is content to merely break even on its Kindle Fire tablets to increase its user base of loyal customers.

(Source: Yahoo! Finance)

Currently Netflix is available on more devices (for how long that advantage lasts who knows) but offers few other advantages. As I have been reiterating for the past year, Netflix has no competitive advantages or significant barriers to entry that can prevent competitors from entering its online streaming space. Netflix is more expensive than Amazon and pales in comparison to Amazon's free shipping offered with Prime. Watching Netflix's epic 75% one year drop in value has been like watching a car accident in slow motion. The company continues to have misstep after misstep and is going to fall lower. In my article cited above I elaborated why Netflix's international operations are going to strain profitability and I predicted the company had two years to recover. This latest Epix news has convinced me that the situation is far worse and Netflix has twelve-to-eighteen months to institute drastic measures in order to keep the company relevant.

The market cap sits at $3.1B and you will likely hear analysts proclaiming that Netflix is an attractive takeover target. I would respond that the company has no real valuable assets in terms of an acquisition so why a competitor spend $4B (assuming a premium of approximately 30%) to purchase Netflix. Amazon offers the blueprint of how a company can enter the streaming business quite easily and deep pocketed rivals such as Apple (NASDAQ:AAPL) could drive the nail in Netflix's business. Remember that currently Apple TV allows consumers to pay for Netflix via their iTunes account. If Apple decides to get more serious about streaming I envision trouble for Netflix as Apple could almost "flip the switch" and do irreparable harm to Netflix.

How To Play It

I expect Netflix to breach its 52-week low of $52.81 and I recommend a long put to capitalize on this decline. The March 2013 $50 Puts are currently trading at $6.85 could experience a material jump on any Netflix declines. Management has already acknowledged that at least the next two quarters will be rocky and I am willing to bet that the stock drops precipitously after one of those earnings announcements. If you are long Netflix and still remain optimistic, please at least consider purchasing a protective put to defend against further losses. The only way that I can envision Netflix appreciating is a new CEO/Chairman is installed but the chances are remote.

Source: Why You Need To Sell Netflix Now Before It Falls Further