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Investing for Nerds: Exploring Netflix

I’m sure all of you are well aware of Netflix’s (NFLX) recent woes. The separation of its DVD and streaming services, combined with a price hike, has prompted an angry outcry from Netflix’s customer base. To save face, the company rebranded its DVD service Qwikster, a change which has been widely ridiculed. Recently, the company has cut its forecast by a million subscribers. This has sent Netflix stock into a plummet of more than 50% of its 52-week high. Now, I’m trying to decide if there is opportunity in this bad press, and if this is a massive overreaction or a reasonable correction.

In July, after the announcement of the service split-up, our own Nicole Campos wondered whether she would keep Instant Play and explored some of her more frivolous viewings. I’m sure most folks had a similar debate with themselves over which service to choose or to just suck it up and accept the new price. As she mentions in her article, an additional $5.99 doesn’t seem like much but, when compared to the $9.99 the service started at, it’s a 60% increase for essentially the same service. As a consumer, I totally understand this sentiment. If Starbucks hiked its prices by 60% I might have to rethink my occasional Salted Carmel Mocha, because $4.50 is a bit steep, but over $7 for a freaking coffee?!?! Robbery!

This customer reaction is basically investors’ worry about Netflix alienating its customer base, and the massive price dip reflects that. We’re no average investors though. No, sir. WE ARE NEEEEERRRRDS (read like the eternally shirtless fellow in 300). Most seem to agree that streaming video is Netflix’s future, and, clearly, CEO Reed Hastings agrees. The company’s management is generally agreed to be pretty good at the whole business thing, so it can’t be that they just lost their shit, right? They acknowledged that the change in service pissed off customers in an official statement, so they seem to get it. The DVD spin-off seems to make sense in that it allows the company to focus on improving their streaming service, which investors should love because everyone agrees that’s where the business is headed.  Sure, “Qwikster” is kind of a dumb name, but was the name “Netflix” that great?

The market tends to overreact to breaking news, and I think that is exactly what’s happened here. No one likes to hear that the company that’s exploded over the last few years is slowing down. But if you think the company was worth its valuation of 60 to 80 times earnings over the last year, you’ve got to love the fire sale that’s brought a P/E of 30 with a future P/E of about 20. Buying now would be a vote of confidence in the company’s commitment to its streaming service. Negotiations with content companies are clearly difficult and this should help it continue to get more content and improve the service.

We should note that this isn’t the first time Netflix has made such a bold change to its services. Former CEO and founder Marc Randolph writes in his blog that he thinks this change is just another example of the laser focus Netflix has showed since its inception. He explains that when the company first started in 1998 it rented out DVDs with due dates and allowed customers to buy DVDs. Randolph estimates that about 95% of its revenue came from selling DVDs after their first year and that it recognized the eventual massive competition that was to come in DVD sales from Amazon and just about every other retailer, so it stopped selling and focused solely on renting. Randolph remembers that this was a difficult decision for him to make but the company realized that “by trying to run a business that did two things well, we inevitably were forced to make an endless series of compromises that resulted in us doing neither of them well.” He praises Hastings and thinks this was a bold move that will contribute to the company being able to build the best streaming service it can.

How can I disagree with someone who, while he hasn’t worked at Netflix for quite a while, has a unique perspective on the company and its current CEO? Personally, I went into writing this article with the intention of stating that there is clearly a lot of potential here but that I wouldn’t buy because their fate lies too much in the hands of others. If Netflix could consistently add to its premium content and complete seasons of popular television shows to continue growing its customer base and become more easily integrated into televisions, then maybe it can convince content providers it’s got the power the way Apple did to the music industry with iTunes. That’s a lot of ifs. But investors look for long term value, and smart management in a burgeoning industry certainly creates plenty of that. I’m not sure I’ve changed my mind, but I’m certainly closer to the fence after writing this, anyway.

What do you think? Were you a Netflix owner before the price plunge and have you kept your stock or sold off? Are you planning on buying now? Or even speak up if you’re a Netflix user with an opinion on where the future of the business is going. Have any recommendations for your fellow nerds or topics you’d like to see me write about?

Twitter: @jontrainor

This column should not be construed as recommending or advising on specific investments. The views and opinions expressed in this article or column are the author’s own and not necessarily those of Nerdist Industries; No endorsement by Nerdist Industries of any advice or trading strategy is implied.

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17 comments

  • “The DVD spin-off seems to make sense in that it allows the company to focus on improving their streaming service”

    What baffles me is that Netflix, according to their not-an-apology, apparently can’t figure out how to do streaming well under one brand. That baffles me. The brand is already there. Whatever “teams” Netflix needs to separate within their company, I don’t care. It sounded to me like the streaming team just wanted to wear different t-shirts than the DVD team, and now I have to long into two different sites because of it.

  • i full bailed on Netflix right before the price hike. it’s more than i can currently afford, and loved being able to stream and still get discs in the mail. my problem with streaming only, is that i watch a lot of bizarre, hard-to-find films, that are rarely on watch instantly. i’m sure i’ll come crawling back, but for now, i’m out.

  • As a Canadian the split is rather irrelevant to me (we never had the DVD service, we only got to know it as streaming), but of just as much concern is the number of items that keep vanishing from the streaming selection.

    The studios know they’ve got Netflix over a barrel at the same time that they’re launching myriad competing services, which make me concerned for the value of the company in the future.

  • I think I understand where Netflix is coming from. DVD’s are going the way of the dinosaur. And a lot of folks only have the DVD plan because Netflix instant streaming just isn’t that current. If Netflix can actually add that “substantial new content” that it is promising in the near future on Instant Streaming, it will do well. But that, I believe, will be the make or break factor. And losing Starz is not putting the company on the right path for that.

  • Speaking from someone who missed the boat once, I won’t do it again!

    I almost pulled the trigger on Netflix the week before they announced the deal with Wii and PS3, and as such missed out on the initial swing. I’ve been waiting for a rebound, and this was way more than I hoped for!

    Regarding the spinoff, this will indeed help the streaming negotiations. Firstly, it gives the parent company the ability to eventually sell Quickster to an interested party, thus completing the divorce. Once done, their negotiations regarding content will be much easier, because studios won’t have the option of discs AND streaming, it will just be do they want their content under the Netflix branding or not. It removes the leverage that the studios currently have of falling back on the discs, and leads the way for much better streaming content. A+ move in my book.

  • doesn’t anybody remember what it was like to have to go to a movie store and rent movies? to rent 2 dvds at a time with a 3 day turnaround (and i get to return it at my leisure), and get unlimited streaming through netflix i pay less than $20/month. when i worked for blockbuster 10 years ago all that $20 would get you was 5 movies (they ran about $4 a piece, if i recall), and the selection was nowhere what netflix has to offer. and how about the price that people pay for cable? now i have thousands of movie and tv options and i’m never without something to watch. so it confuses me to see people whine about paying less than $1 a day for unlimited viewing and dvds delivered to their door/tv/computer.

  • I’m watching this stock like a hawk. At the time of this writing, Netflix’s stock is down to a third of its 52-week high. I think it will continue to drop as more and more punditry comes out against its recent moves. This will be a definite buying opportunity soon. Hell, I think it’s a decent buying opportunity now.

    Netflix is a smart business. The stock will recover – maybe not to the insane heights of the last year, but it will recover. As a business, I think they are strong. The streaming field is just gathering real steam, and Netflix is way ahead of most of the competition (the closest being Amazon, I think, with its Prime content). At some point, I see Netflix being acquired, just as I see Hulu probably dropping by the wayside unless they can get more content.

    Just my two cents.

  • At one point in time I was getting 3-discs a time from both Netflix and Blockbuster Online (trading the envelopes in for store rentals) with an additional disc or two from Greencine (since they have a lot of movies that never Netflix nor Blockbuster carried) every week.

    I wouldn’t really have been that upset about the price change except that other factors happened in my life where I can’t afford it. So I’m just streaming on Netflix and torrenting the rest. The Netflix deal with unlimited streaming was always too good to be true so I appreciate getting to use it like I did and still mostly find it still worth having. The big issue isn’t the price but the content available. I don’t care if it doesn’t have all the new releases if it at least has plenty of older movies that I love to watch over and over again.

  • I have been with netflix since almost the begining (when they didnt even HAVE streaming), and the price went up consistantly for the last what? 10 years? so to me, it is not a big deal. i supose if you started with them recently, it might be more of an issue. My issue used to be that you couldnt get unlimitted streaming and less than 3 dvds. i like that they are seperated now, and that i can get unlimited streaming and only 1 dvd for less than 20 bucks a month. i think most people are overreacting. i mean really? 20 bucks a month? people spend more money at Dunkin Donuts in a week!

  • Physical media isn’t going anywhere in the near future. The tech-savvy always want to believe that “everyone” is as up on the latest tech as they are, but the general public is a few years behind. DVD/Blu-ray will still be around ten years from now, maybe twenty. Eventually the world *will* go all-download, but it won’t be in 2012 or 2013.

  • I am a long-time, committed Netflix customer and I am 100% on board with this current direction of theirs. Started using their disc service in grad school maybe 5 years ago because it was more cost-effective than going to the theater, and when they took the restrictions off streaming in 2008 I found myself streaming things more and more often. Dropped the disc service entirely about a year ago because all we did was stream content, anyway.

    I think Netflix’s streaming services work best for people like me, who have dropped cable but want to watch or re-watch a lot of TV that isn’t necessarily new. It also works great for cult classic movies, which is what I tend to hunt for at the video store. People who avoid movie theaters and still watch cable might only want to rent the newest blockbuster films, and it seems like they are the ones who are not happy with the streaming service. Everyone I know who enjoys it has given up cable and still goes to the movie theater every once in a while.

    I should note that I’ve never had the luxury of a DVR, so I never really had the equivalent experience of on-demand content just from cable.

  • The price hike was a dig. The “We screwed up, we’re sorry, but not really because now we’re going even further with it” video about splitting into two companies was insulting. The fact that now customers have to pay more AND manage two separate accounts to do what Netflix did just a month ago is just plain dumb. I don’t understand why anyone stayed.

    DVDs are a must. Besides the bonus material (I am a nerd), there are just too many things missing from the streaming catalog. I’ve been without Netflix for just over a month now and have not missed it for one moment.

    (BTW, my public library has an online catalog, a pretty good selection of DVDs (and other material), and they let you check out more than one at a time. Oh yeah, and it’s free.)

  • I bailed on Netflix in August. A 60% price increase is just not acceptable. I don’t care how much of a “deal” it is… that kind of increase in this economy is ludicrous. Since then, they lost Starz, dropped the turd that is “Qwikster” on us and their stock has been halved. I feel like I left at just the right time. This service is going down, down, down. How can you kill off DVD’s before streaming is ready to deliver a similar catalog and feature set (5.1 Surround, etc.)? Reed Hastings has damaged his company and his brand in a relatively short amount of time. I’m not sure they can recover from this. My money is going to Amazon Prime. And the death spiral continues…

  • I’m frankly worried about Gamefly.

    Qwikster is apparently also including Video game rentals, and people may find it convenient to have one service that provides both types of rentals.

    If you think about it, it is really hard to find actual physical rental stores for video games anymore.

    You either have to buy a 60 dollar game, return it and only get 12, or maybe 13 dollars if you thought it was really shitty, or get Gamefly.

    The service is nice, but Qwikster would already be starting with the shipping centers that Netflix has already established.

    I like Gamefly, and it may get absorbed if Qwikster catches on, which means they would have complete control over Video Game rentals, as well as their prices. Making it almost non-competitive.

    A lot of people are overlooking this, and I’m pretty concerned about the Video game rental “scene”.

    I’d rather try games before I buy them.

  • Actually, I think this is the beginning of the end for Netflix. As a streaming-only service, what makes it any better than Amazon Prime (which also offers me tangible benefits on “physical” items) or some future YouTube or FaceBook or…? What differentiated Netflix was the ability to get DVDs… sent to my door… with zero hassle. Genius. By the time everything on DVD (and more?) is available as an on-demand stream, I’m confident I won’t need Netflix. I’ll be able to shop any number of “channels”, and a la carte as I choose. I mean, what’s stopping G4TV from charging me $0.25 to watch an AotS episode, or charging me, say, $10 for a year subscription? Nothing. Older properties (movies, TV shows, etc) could likewise be offered directly from the rights holders. There is no need to single-source in a streamed world. Unless Netflix can provide me with something I can’t get by tabbing over to a different web page, they’re doomed.

  • I was about to pull the trigger and subscribe. But I delayed because the streaming catalog is mostly not HD, and the DVD catalog usually doesn’t have the extras, extras disks have to be sent separately from the main title, and BD costs extra. And then I found that most of the movies I wanted weren’t available anyway. And now, the Starz original series I watch are also gone?

    Netflix, tell you what. Get arrangements with Syfy, BBC, and maybe some other broadcast new-content providers [Cartoon Network/Adult Swim, The Hub, Fox (Fringe), ABC (The Big Bang Theory)] for same-day streaming, and then maybe we’ll talk.