Why leave the comfort of your own home to rent a movie for $4.99 and worry about incurring late fees when you can instantly stream films online? For only $7.99 a month Netflix (Nasdaq:NFLX) offers unlimited 24-hour access to thousands of movies and TV shows, which can be simply ordered online.
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With nearly 17 million subscribers, Netflix has modernized the way people watch movies. Much like Amazon (Nasdaq:AMZN), which adopted a business model without brick-and-mortar facilities, Netflix is bringing similar changes to the movie industry. With rapid changes in consumer behavior patterns, Blockbuster and Movie Gallery both filed for bankruptcy earlier this year.
Undoubtedly, NFLX has been one of the hottest stocks on the market, producing returns of 220% over the past year. Since going public in 2002, Netflix has produced a total return of over 2000% as its revenues increased from $153 million to over $2 billion for 2010. Furthermore, despite reducing its price from $20 a month to $9.99 for DVD mail delivery services, management has managed to run the company more efficiently and improve operating margins every year since the IPO. As Netflix begins to rely more on streaming content rather than mail services, margins are likely to continue to improve.
Netflix was probably largely helped by the recession as basic earnings increased from $1.36 in 2008 to $2.05 in 2009 and the number of users increased from 9.4 million to 12.3 million. However, as the recession fades, Netflix continues to grow at a rapid pace.
With a strong balance sheet, stellar cash flow performance, a $300 million share repurchase plan, effective management (CEO Reed Hastings was Fortune's businessperson of the year) and ample growth opportunities, investing in Netflix has one main draw back: the current $185 stock price.
In a December 16 article that appeared on SeekingAlpha.com, Netflix bear Whitney Tilson makes a strong argument that the rapid shift to streaming movies marks the beginning of the end for the company. Basically, the industry has undergone massive changes from brick-and-mortar facilities, to mail subscriptions, to now, streamed content. As the online business grows in importance, Netflix will be competing with big-name competitors such as Apple (Nasdaq:AAPL), News Corp (Nasdaq:NWS), Google (Nasdaq:GOOG) and Amazon, among others. Due to the increase in competition and Netflix's high margins, which have spurred resentment from movie studios, profitability is not likely to reach the levels implied by the stock price.
Additionally, in order to compete with other big name players, Netflix will have to significantly expand its content base, an area in which it lags its competitors. Based on the analysis conducted by Whitney Tilson, Netflix had only 17 of the most popular 120 movies of interest; in comparison, Time Warner Cable's (NYSE:TWC) video on demand had 41 and iTunes carried 77 titles.
Adding more titles will not come cheap, especially if Netflix begins offering newer titles. Although the company has been able to expand its library for a relatively low price in the past, this trend is likely to reverse. In 2008, Netflix paid approximately $25 million to Starz for its content; according to the New York Times, media analyst Michael Nathanson called it "probably one of the dumbest deals ever. Starz gave up valuable content for tens of millions of dollars.'" When such contracts are renewed, Netflix is unlikely to get such a stellar deal, which will surely hurt the company's margins.
While Netflix may one day become the movie equivalent to Apple's iTunes, competitors will not let this be an easy road. (These dreams are likely to burst - and may blow away your financial future in the process. See 4 Fatal Financial Fantasies.)
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