Netflix Can’t Win the Streaming Media War

by Lawrence Meyers | November 1, 2012 7:30 am

Netflix Can’t Win the Streaming Media War

The battle over the delivery of streaming media is well under way. The three main players — Netflix (NASDAQ:NFLX[1]), Coinstar (NASDAQ:CSTR[2]) and Amazon (NASDAQ:AMZN[3]) — are at each other’s throats, so to speak. Each company has had major developments in the streaming battle recently, and each company offers a way for investors to profit.

I have been bearish on Netflix for some time and its present operations show precisely why. The company lost another 634,000 DVD subscribers in the last quarter — not very comforting even though its less than the 849,000 lost the previous quarter, and less than the 1 million lost in Q1.

The reality is simple: DVDs are dying. I think in less than three years, everyone will be streaming content and DVDs will be as obsolete as vinyl records. This is bad news, as the DVD side of the business has much better margins.

On top of that, Netflix now has to deal with streaming costs. It has $5 billion of content obligations to fill. The company sits on a net of $400 million in cash but has only generated $40 million of free cash flow this year. How exactly are they going to pay that $5 billion in content costs? I say they won’t be able to. Netflix is a short for this reason alone, and the fact that competition is heating up only adds to that case.

The question, though, is whether some entity will buy Netflix. There are rumors, for example, that Microsoft (NASDAQ:MSFT[4]) is a potential suitor, but I don’t think that possibility makes any sense. Sure, Microsoft has the money, but why would they buy a platform with enormous (and growing) competition and $5 billion in content obligations?

Carl Icahn’s much-ballyhooed 10% stake[5] implies changes are afoot for Netflix, but how the billionaire investor plans to wring value out of the company is yet to be seen.

Netflix isn’t just facing Coinstar and Amazon, but also tech powerhouse Apple (NASDAQ:AAPL[6]). And how long will it be before Google (NASDAQ:GOOG[7]) enters the fray?

It’s was one thing to buy Skype for $8.5 billion when there wasn’t that much competition. It’s another to buy into a rapidly commoditizing market.

Coinstar, on the other hand, (NASDAQ:CSTR[2]) is a solid long-term play. The beauty of this company is that it has a recurring revenue stream from its coin-counting business. That segment increased by 3%, while Redbox revenue increased 18%. The company has generated $175 million in free cash flow so far this year as it transitions its NCR kiosks and moves into the coffee and ticket businesses.

Allegedly, the company’s streaming partnership with Verizon (NYSE:VZ[8]) will allow it to move into competition with Netflix and Amazon. If true, this should be a huge success because Verizon will very likely pick up the majority of the costs, as it has deeper pockets. At the same time, though, it’ll also likely take the majority of the revenue. Regardless, once Coinstar and Verizon enter this space, the squeeze will be on for Netflix.

Amazon (NASDAQ:AMZN[3]) has been steadily increasing its content offerings and can afford to keep doing so with over $5 billion in cash. Netflix simply will not be able to compete with pockets this deep. Amazon remains the premier online retailer, and despite weak Q3 earnings, I think it’s a buy for the long term.

As of this writing, Lawrence Meyers did not own a position in any of the aforementioned securities.

Endnotes:
  1. NFLX: http://studio-5.financialcontent.com/investplace/quote?Symbol=NFLX
  2. CSTR: http://studio-5.financialcontent.com/investplace/quote?Symbol=CSTR
  3. AMZN: http://studio-5.financialcontent.com/investplace/quote?Symbol=AMZN
  4. MSFT: http://studio-5.financialcontent.com/investplace/quote?Symbol=MSFT
  5. 10% stake: http://www.reuters.com/article/2012/10/31/us-netflix-stock-idUSBRE89U1GA20121031
  6. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  7. GOOG: http://studio-5.financialcontent.com/investplace/quote?Symbol=GOOG
  8. VZ: http://studio-5.financialcontent.com/investplace/quote?Symbol=VZ

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