Market Overview

Five Reasons Why Netflix Won't Be Around in Five Years

Your favorite DVD and streaming video service is on the cusp of destruction.

Reed Hastings, the CEO of Netflix (NASDAQ: NFLX), knew his enterprise was in trouble the moment he saw the response to the company's infamous DVD hike. But he had no idea that his stock would continue to tumble for the rest of 2011, trading below $70 toward the year's end.

Consequently, the Netflix brand has become synonymous with negativity. “Is Flagstar (NYSE: FBC) the Netflix of banking?” I wrote in November. “Barnes & Noble (NYSE: BKS) is the Netflix of 2012,” I proclaimed this month. In both cases, the comparison to Netflix was not intended to be a compliment.

Now it has become apparent that no matter how well Netflix performs in the coming years, its days are numbered.

5. DVDs Are More Profitable Than Streaming

Content providers love to tell us that streaming is the future of entertainment. That may be true, at least as far as video rentals are concerned. But unless content deals with movie studios and TV networks begin to improve (read: become cheaper, last longer, etc.), Netflix will not be able to survive as a streaming business.

In fact, it turns out that DVDs – the business Netflix tried to kill off last year – accounts for 52.4% of the company's contribution margin. Streaming video, on the other hand, accounts for just 10.9% of Netflix's contribution margin. Regardless, Hastings was eager to tell the press that he expects DVD subscribers to decline steadily every quarter – forever. Netflix would love to blame this on the fact that consumers are losing interest in the DVD format, but it's safe to assume that the majority of the cancellations (nearly three million in the fourth quarter) were caused by the price increase.

Hastings cannot say for sure when the margin for streaming will improve. Streaming is a costlier beast, it seems, because content deals are so expensive and so limited. Netflix's DVD library is several times the size of its streaming option, and that isn't likely to change anytime soon.

Meanwhile, the New York Post reported this week that Amazon (NASDAQ: AMZN) may launch a new version of its streaming video service, one that would be separate from its annual Amazon Prime package.

4. Rising Competition

As if the increasing threat of Amazon and Hulu weren't enough, Netflix now competes directly with Comcast (NASDAQ: CMCSA), which re-launched its streaming video features under the Xfinity brand name. Time Warner Cable (NYSE: TWC) offers a streaming option as well. Rumors suggest that Verizon (NYSE: VZ) is developing a new streaming video service that will be separate from its other pay TV offerings. Further, Dish Network (NASDAQ: DISH) is attempting to build up its streaming and DVD-by-mail offerings obtained from the Blockbuster acquisition.

The list goes on and on. And with every new competitor, Netflix is faced with two major problems: (1) another video service for consumers to choose, and (2) another service that could land exclusive content deals.

3. Limited Contracts

When Netflix first launched its streaming service, many users were under the impression that the available videos would be there forever. After all, DVDs can stay on the shelves of Blockbuster and other video rental chains for 10 or 20 years before being completely removed. Only those that customers abandon will be removed from the shelf. The same is mostly true for Netflix's DVD business.

But it has not been the case for its streaming content, which is limited by contracts, licensing, and a plethora of issues that may forever prevent the cloud from becoming a reliable source of entertainment.

Granted, Netflix isn't the only company affected by these limitations. After losing all but the most recent episodes of 30 Rock, Hulu Plus recently posted the following notice: “Due to a legal rights issue, 30 Rock is no longer available in Hulu Plus.” This could theoretically work to Netflix's advantage as consumers look elsewhere for their 30 Rock fix (DVD subscribers can still rent it).

But the opposite is true when Netflix loses a film or TV series. If the last 12 months are any indication, it seems that Netflix loses content faster than anyone else.

2. New Content Deals Are Weak

In the absence of Disney (NYSE: DIS) and Sony (NYSE: SNE), which were lost the moment Starz said goodbye, Netflix struck a deal with – drum roll, please – DreamWorks Animation (NYSE: DWA).

The deal is great for DreamWorks, which will be handed large buckets of cash for every movie it delivers. Netflix, however, is getting the short end of the stick. Sequels aside, DreamWorks hasn't had a breakout hit since How to Train Your Dragon was released in 2010 (hence the reason why the company is planning to milk the property and release a sequel). Kung Fu Panda 2 did well, but it was a sequel. Puss in Boots proved to be profitable, but it was a semi-offshoot of the Shrek franchise.

Even if DreamWorks managed to release three hits per year for the next several years, the animation studio would still be worth less to Netflix than Disney, whose massive catalogue of animation hits may never be rivaled. Add Pixar to the mix and it's easy to see why Disney continues to lead the world of animation.

Other than DreamWorks, Netflix did not make too many big (exclusive) announcements in 2011. After striking deals with Miramax and The CW, Hulu did the same.

1. A Merger is Inevitable

While it was once believed that Netflix could be the next Comcast, it is now clear that the company is incapable of competing on a long-term basis. Sooner or later, one of Netflix's competitors (or, perhaps, a new player looking to enter the market) will make a buyout offer. Right now, the top reasons to acquire Netflix are (1) the subscriber base, which is still very large, and (2) the brand name, which is still the strongest in streaming video. In the future, however, Netflix might have a content deal that a competitor would love to take advantage of, thus inspiring merger talks.

For now, however, Netflix is stuck with weak content deals, a dying (?) DVD business, and a clueless chief executive.

Follow me @LouisBedigian

Alternate View: Brett Callwood finds positivity in what he believes to be a comeback for the streaming video service.

Posted-In: Amazon Prime Blockbuster Hulu Netflix Reed Hastings XfinityTech Best of Benzinga

 

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