Netflix Reverses DVD, Streaming Split

Netflix Reverses DVD, Streaming Split

by Justin Dove, Investment U Research
Tuesday, October 11, 2011

The broad market sell-offs over the past few months were especially brutal on Netflix (Nasdaq: NFLX). That’s because, in July, Netflix announced that it was raising prices and splitting its streaming and DVD rental businesses.

The decisions led to a mass exodus of over one million customers and the stock falling 65 percent between mid July and late September. The stock even fell 19 percent in one day on September 15 after Netflix announced it was expecting to lose 600,000 customers for the quarter rather than adding the 400,000 it had forecast.

While it was obvious the company was headed for a rough patch due to insanely high valuation and the rapid emergence of competitors, not many saw this much of a dip coming. Although the broad market sell-offs due to global recession fears have certainly played a part, the market has definitely spoken in terms of Netflix.

Therefore the company announced on Monday that it has decided to rescind its previous decision to split its DVD and streaming services into two different product offerings.

Netflix: Too Little, Too Late?

Jeff Reeves of MarketWatch.com feels that “this Netflix debacle is not so easily resolved by wishing it away.”

He gives three reasons as to why he feels Netflix won’t rebound from this debacle:

• “Some subscribers are gone for good” – Reeves argues that the whole thing may have left a bad taste in the mouths of many subscribers. He also cites that Netflix doesn’t offer a good enough catalogue of new releases and that many “mildly dissatisfied customers sometimes stick around out of laziness or complacency. Once they’re gone, however, they need more than the status quo to return.” I can certainly see the validity to this point.

• “DVD business publicly revealed as disposable” – This is probably Reeves’ biggest stretch. He argues that somehow former customers’ feelings will be hurt by feeling marginalized, and they’ll never return. I don’t buy this. I think most customers are simply worried about a price point in this industry and Netflix rose above that. First by raising its prices, and second by splitting options for its customers (effectively raising prices even more).

• “Netflix’s poor leadership exposed” – This could be a valid point. Netflix did execute poor judgment with its decisions to raise prices and lower customer options. It’s also disheartening that it failed to come to terms with Starz and will lose that content in January. As Reeves points out, Starz’ content currently makes up eight percent of its streaming library. However, one good sign is that the company understands its mistakes and isn’t being stubborn. It would be much more disheartening to see Netflix act like the stubborn Co-CEOs over at Research in Motion (Nasdaq: RIMM).

The Future Success of Netflix

Although Reeves makes some good points about the future success of Netflix, his bearishness may be a bit overstated. Its current P/E ratio at roughly 30 is much more palatable than the highs in the 80s back in July. And at least management can own up to its mistake in judgment and try to fix it.

Losing the Starz relationship will definitely hurt, considering it likely means Netflix will lose the rights to stream films from Walt Disney Studios and Sony Pictures Entertainment. But it’s adding DreamWorks Pictures to the fold for 2013, which should offset some of the losses. It’s also beginning to generate its own content, which it hopes will separate it from similar services.

“House of Cards,” will be Netflix’s first original show, which is expected to premier in late 2012. According to The New York Times, it’s also in talks to distribute new episodes of the cancelled sitcoms “Arrested Development” and “Reno 911.”

It’s unlikely Netflix will see its highs of $300 a share again anytime soon. But it’s also probably a bit oversold due to the broad market sell-offs and overboard bearishness. Investors may want to keep an eye on Netflix, as this could be a low point for the stock.

Good investing,

Justin Dove

Article by Investment U