Netflix (NFLX) is arguably the most controversial stock in the market right now. With the recent mishap of CEO's Reed Hastings decision to split the company into two - a streaming division and a DVD-by-mail division - only to backtrack shortly after while still fresh on investors' minds, rise of competitors, and looming content deals, it seems fashionable to talk this stock down. That is a mistake however, Netflix is still a very good stock to have and will be far into the future.
Management at Netflix has taken heat for its decision to split the company in two. But what may be lost in the episode is the fact that Netflix listened to its customers and backtracked on its decisions - something you want a management team to do. This management team is strong, it recognizes that growth in the U.S. market is still there, but is limited. That is why it is beginning an aggressive campaign to make Netflix a global provider of content. When Netflix announced their plans it met with a lot of fear amongst investors - would the expansion result in increased profits given the increased costs associated with such an expansion, and were there enough markets with broadband access that can support the content streaming that Netflix provides? These concerns led to Netflix losing 44% of its price. We are now seeing answers to these questions.
Last week Netflix launched its online video services in Sweden, Denmark, Norway, and Finland. Initial signups "exceeded expectations." Scandinavia is a ripe environment for Netflix expansion given that there is estimated to be some 10 million households with broadband service in the area. Entering this market will give Netflix a big boost going forward. Further, there are plenty of other markets ripe for Netflix expansion - including Western Europe, South America, and the Far East. While aggressive expansion will raise costs and negatively impact profit, those initial costs are far outweighed by the fact that Netflix will very quickly see payoff from these moves and the fact that Netflix stock is already trading at a heavy discount.
In recent years Netflix has seen increased competition. Amazon (AMZN) is now streaming video to subscribers and as a pay-per-view service. Amazon has recently increased its online library of movies and television shows but it is still dwarfed by Netflix's catalog. Amazon also lacks the marketing emphasis that has made Netflix the leader for streaming video. This is because Amazon's strategy is not to take Netflix on as a direct competitor but rather to make Amazon's streaming library another reason for customers to stay within the larger Amazon shopping environment. Amazon offers its video library for $79 a year, which is $5 cheaper than Netflix, through an Amazon Prime membership. Customers buy an Amazon Prime membership and receive free shipping on most order along with other benefits. Amazon is using its streaming library to attract customers to the Amazon Prime membership thereby keeping them within the overall Amazon shopping community. Netflix has little to worry about Amazon as a direct competitor.
Coinstar (CSTR) is the operator of Redbox, kiosks set up around the country where people can rent a DVD for as little as $1 a night. But just like Amazon, Coinstar is not looking like a direct competitor to Netflix. The target customer for Redbox is the person who watches two or three movies a month, not someone who streams movies and television shows to their home televisions and mobile devices. Netflix has long recognized that its future does not lie with hard copy DVD rentals but rather online streaming. Redbox might attract a few budget-conscious consumers who might otherwise subscribe to Netflix, but the competition is negligible and should remain so for the foreseeable future.
Comcast (CMCSA), in partnership with Disney (DIS), and News Corp. (NWS) offersHulu, an online video provider that offers streaming video on demand to its customers. Hulu operates very similarly to Netflix's model - customers pay a monthly fee to have unlimited access to content. But Hulu has not proved to be a real threat to Netflix and will not be one going forward. It has been around for several years, offering the same type of service and has not made any appreciable dent in Netflix shares. Hulu's content library is small and customers must watch commercials despite paying a monthly fee.
Netflix has also been talked down because of looming content deals that are expiring soon. Some analysts believe that the expense to maintain existing content and garner new content will be too much for Netflix and that the stock will suffer as it sees its customer base shrink. The problem with this line of thinking is that it ignores what additional content will bring for Netflix. One of the biggest criticisms of Netflix by consumers is that its online video library lacks high quality movies. Paying for new content will no doubt be expensive for Netflix, but the payoff will be great. A larger movie library will add subscribers and further set if off from competitors as the best service for streaming video content.
Netflix is currently trading at around $69 per share. It was trading near $130 as early as first quarter of 2011. Since that time Netflix has only seen good news. Amazon is not threatening to add the titles necessary in order to compete against Netflix, Redbox's streaming services are still far from getting off the ground, and Hulu still has a small library and requires customers to watch commercials. Netflix is aggressively expanding internationally, and one of the first domestic companies to do so. The future is bright for Netflix, even if it will see a decline in profits next quarter due to its expansion costs. Nonetheless the true value of Netflix is higher than $67, and going forward it should soon see its high it achieved earlier this year.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.