Netflix (NFLX) today is a lot like Green Mountain Coffee Roasters (GMCR) when it traded at high valuation multiples years ago. At the time investors would swoon over how it was able to sell coffee, a commodity, in little cups to consumers for a huge markup. They bought GMCR shares at huge valuation multiples without a second thought about other entrants competing in the pre-ground, single-serving coffee market.
This story did not end well for investors who bought GMCR shares at high valuation multiples. The mere threat of competition from Starbucks (SBUX) sent shares of this innovative company plummeting. A similar story is unfolding for Netflix.
Netflix could see further multiple compression as competitors challenge its market.
Plenty of Competition
Coinstar's (CSTR) Redbox has partnered with Verizon Communications (VZ) to challenge Netflix by offering movie sales, rentals, and subscription streaming by Christmas, along with DVD's which are currently available from their local kiosks.
Currently, Redbox Instant by Verizon is being tested by about 500 Verizon employees. Its catalogue will initially focus on newer movies that are available for sale and rental. This will compete with both Netflix and Amazon (AMZN) for consumers who want to watch movies and TV shows online and on mobile devices such as the iPhone. During the first half of 2012, the market for subscription streaming in the United States rose to over $1 billion.
At the end of June, Netflix had approximately 24 million U.S. subscribers for its streaming service, which probably makes it Redbox's largest competitor. (Subscriber numbers are not disclosed for Amazon's service which provides access to more than 20,000 TV programs and movies.)
Earlier this year, Redbox announced its plans to offer à la carte purchases for download and online streaming. With this change customers could easily download content directly to their set-top boxes, game consoles, and mobile devices. At the moment, it is unsure when this service will be available, but it is expected to be launched somewhere between late November and mid December, after it has been publicly tested.
Redbox Instant has yet to announce their pricing for this new service, but Coinstar's chief executive officer has mentioned that the venture is going to focus on value pricing.
Room to Fall
Netflix investors have already seen huge price declines, but this does not preclude more price declines. Consider the following financial metrics:
EPS Growth Past 5 Years
EPS Growth Next 5 Years
Sales Growth Past 5 Years
Green Mountain Coffee Roasters
Consider what happened to Green Mountain Coffee Roasters. It now trades at a price-to-sales and price-to-earnings multiples that are far below its quick-service coffee competitors Starbucks and McDonald's. This was once a growth stock and it has fallen to multiples which might qualify it as a value stock.
Notice also that Green Mountain Coffee Roasters is not being punished for a lack of growth. It has historical sales and earnings growth that trump its competitors. It also has analyst forecasts for earnings growth that outshine Starbucks and McDonald's. Despite this promise, the stock is being punished for falling from grace. Investors are afraid that its larger competitors will destroy this upstart entirely.
The same price decline could happen to Netflix as competitors jump into the streaming video market. Today Netflix trades at higher price-to-earnings multiples than Coinstar or Comcast. If the price declines of GMCR are any indicator, shares of NFLX could trade for less that the valuations of its competitors in the future. If the Green Mountain Coffee Roasters cautionary tale is any indicator, the healthy growth trajectory of Netflix could offer no protection from fears of its eradication from larger rivals.
Valuation matters and even firms which seem to have no competition attract the attention of other firms when they flaunt high growth and high margins. Expect even more firms to compete with Netflix in streaming video. Investors who are looking for innovative companies to invest in should consider Green Mountain Coffee Roasters long before they consider Netflix. No matter how daunting the competition, at least its shares are trading at attractive valuations.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.