Netflix makes it hard to run full speed with bulls

January 27, 2011

By Robert Cyran
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Netflix is making it hard to run full speed with the bulls. The Internet video company keeps defying the studio executives questioning its business model and short sellers piling into the shares. Netflix added an astonishing 3.1 million net subscribers in the last quarter alone, bringing its total to more than 20 million. But worrying signs are cropping up.

There can be little doubt Netflix has grabbed the attention of the media industry. Time Warner boss Jeff Bewkes recently disparaged the company by comparing it to the Albanian army. Yet Netflix’s continued growth weakens that assessment. The bigger it gets, the more heft it has in negotiations with Hollywood and other content providers. Consumers tend to be agnostic about who is producing their favorite TV shows and movies, since they don’t have a billing relationship with those conglomerates.

What’s more, Netflix is becoming more profitable. The firm now thinks operating margins on its U.S. business will run about 14 percent for the next few quarters. That means more cash to spend on attracting customers, buying content, strengthening its technology or buying back shares.

Netflix is entrenching itself as one of the most important video middlemen, even if it’s as a complementary service rather than a replacement for cable or satellite. If it can replicate this overseas, the stock may even be cheap after another 15 percent surge on Jan. 27 put its value at more than 50 times estimated 2011 earnings.

Yet there are a few nagging details. For one, Chief Executive Reed Hastings is looking increasingly thin-skinned. With roughly one in five of the company’s shares being shorted, his frustration is understandable. Late last year, Hastings responded to one critique, saying the company was nowhere near market saturation and that rivals such as Hulu don’t present an immediate threat.

Perhaps, but Netflix isn’t necessarily helping its case. The company has decided to disclose less information, including how many customers are dropping the service. Churn figures are pretty widely reported by such subscription-driven businesses. Almost 9 percent of Netflix customers were on free trials at the end of 2010 — and the figure is growing quickly. Investors aren’t concerned about that now. But if Hastings is so confident, he might find the better way to starve the bears in the long run is to feed the bulls instead.

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