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Netflix’s Winning Streak Faces Challenges

It will take cunning and luck to maintain success


It’s been said that the true measure of success is the number of new challenges you face as you move forward. By that measure, Netflix (NASDAQ:NFLX) is one of the most successful companies in the tech sector.

Three months ago, Netflix was facing a rising tide of pessimism centered around its ability to keep profit margins healthy during the coming years. Then the company delivered an earnings report that dispelled those concerns, spurring a rally in the stock that has added 28% to its value.

But Netflix hasn’t had a chance to breathe easy because a number of new challenges have arisen that could pose new problems for the DVD and online-video heavy. On April 25, when Netflix executives hold a conference call with analysts, they may be addressing the new concerns.

For one, Amazon (NASDAQ:AMZN) is planning on launching an Internet-based service for consumers to stream videos. Of course, Amazon has been selling digital movies, or streaming them on its site, for years — without really making a dent in Netflix’s growth. 

But Amazon showed it is serious about online video when it allowed unlimited streaming for Amazon Prime members.

Amazon, like Netflix, knows the Internet is about to conquer the living room through digital video. Google (NASDAQ:GOOG) knows it too, which is why the company is revamping YouTube to include 20 or so channels devoted to “professionally produced original programming,” as the Wall Street Journal put it.

So Netflix’s golden living room is getting crowded. Now consider what is perhaps the most serious development of all: Apple (NASDAQ:AAPL) appears ready to make an aggressive move into online video. With AppleTV, the company made clear it was merely experimenting with a living room appliance that connected to Internet videos. Now, Apple may be taking things to the next level.

On Tuesday, Jeffries analyst Peter Misek issued a note saying that, based on channel checks with developers and content providers, Steve Jobs could be planning a “final hurrah” with yet another new Apple device that could “revolutionize video much in the same way Apple has transformed the mobile, computing and music worlds.”

Netflix could play a role in Apple’s future video plans, just as it does with AppleTV today. But Apple likes to get its 30% commission when it can in media passing through its hands, and Netflix may be asked to start splitting revenue with Apple in the future.

There are other developments that bode ill. As Jeff Reeves pointed out, Dish could become a competitor now that it’s bought the library from Blockbuster in bankruptcy. And Level 3 Communications (NASDAQ:LVLT) and Global Crossing (NASDAQ:GLBC) are merging, which could trigger the kind of consolidation in the sector that leaves companies with strong pricing power.

Of course, Netflix isn’t standing back idly. It’s expanding its online-streaming service internationally, starting with Canada. And it’s aggressively negotiating to get licenses to stream popular titles like Mad Men as well as other titles from HBO.

But negotiating for a bigger video library will likely grow trickier if Google, Amazon and others are in the fray. Last month, the Criterion Collection, a respected distributor of classic movies, jumped from Netflix to Hulu because they didn’t like how their titles were lost in Netflix’ growing list of titles. This was an unwelcome loss. The percentage of the movie-going population who go for films like Bergman’s The Virgin Spring may be small, but it’s a fiercely loyal group of cineates.

All of these developments add up to the likelihood of more pressure on Netflix’ profit margins. According to the Convergence Consulting Group, a research firm, Netflix’s content costs rose to 25% of revenue in 2010 from 15% in 2009 and is forecast to rise to 39% this year. Cable and broadcast companies pay about 42%.

Netflix has a history of defying naysayers and finding a way past obstacles. But it seems to be facing a lot of new obstacles as well as older ones that — like Amazon and Apple — are becoming bigger obstacles. It will take a lot of cunning and luck for Netflix to hang onto the success it’s achieved.

Article printed from InvestorPlace Media,

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