Why Netflix Will Never Be Great Again

Netflix will never be great again
Netflix will never be great again

It only takes two months to go from hero to goat on Wall Street.

Just ask Netflix (NFLX). The video rental giant has gone from hitting all-time highs just two months ago to busting through new 52-week lows this week. (Here's a graphical representation of the ugly dive.)

The flop has been brutal, and Netflix can't blame anyone else for its woes. Its decision to begin charging subscribers on unlimited DVD plans $7.99 a month for streaming -- something that they have enjoyed for four years at no additional cost -- has backfired.

Making matters worse, CEO Reed Hastings wants to create two stand-alone realms. Streaming customers can stay at Netflix.com, while DVD-loading subscribers are banished to Qwikster.com -- a site that presently consists of a promotional landing page, but in a few weeks will send DVDs, Blu-rays, and now even games to old-school optical-disc users.

Netflix acted so quickly that it couldn't even secure the Qwikster handle on Twitter. (The handle is owned by someone who, until earlier this week, had a marijuana-smoking Elmo as his icon. Not so "qwik" there, huh, Netflix?)

It's been a devastating fall from grace for a dot-com juggernaut that should have known better.

Couch Potatoes Throwing Rotten Tomatoes

In less than two months, Netflix has gone from targeting 25 million domestic subscribers by the end of this quarter to just 24 million members.

Couch potatoes clearly aren't all that Netflix has lost. A battering ram is being taken to the fallen darling's reputation, and it's hard to fathom how long it will take to mend.

Hastings's company is an easy target in these Web 2.0 times. Even on its Facebook page, the vast majority of the thousands of "fan" comments that are pouring in are as scorching as they are negative.

Miscommunication Breakdown

It shouldn't have come to this.

July's decision to begin charging for streaming was not a price increase to half of its user base. It was even a price cut to a couple million of Netflix's then 24.6 million domestic subscribers. Was this ever portrayed accurately?

No. The media pounced on the notion that this move was a "price increase of up to 60%" -- which it technically was to a small subset of users on the single-disc unlimited plans -- without breaking it down appropriately.

Netflix expects that 9.8 million of its 24 million stateside subscribers by the end of this month will be exclusively on streaming plans. This offering hasn't changed since it was launched several months ago for $7.99 a pop. It's the same plan -- at a similar price point -- that Netflix rolled out in Canada last year and through Latin America and the Caribbean earlier this month.

Then we get to the 2.2 million accounts that Netflix is targeting to be exclusively on DVD plans. These prices didn't go up either. In fact, rates for the popular "unlimited" DVD plans were knocked down by $2 a month this summer. This leaves the remaining 12 million -- the ones on dual plans -- feeling the pain. They're paying $7.99 a month more to stream, offset by the $2 price cut on mail-served DVDs.

The increase on half of Netflix's users may have been insensitive, but it was necessary. Studios weren't going to let Netflix have popular movies and shows for a service that was treating streaming as a Happy Meal toy premium. Tinseltown has a value proposition to protect, and splitting the plans helps.

However, instead of clarifying the move and justifying the underlying thought process, Hastings gave a half-apology and offered plans to make life even harder for his company's highest-paying 12 million subscribers.

Qwikster? Really? Dual logins? Dual queues? It's a double disaster.

Anatomy of a Valuation Breakdown

It's not easy to watch the stock shed 57% of its value since peaking two months ago, and I say that as a longtime shareholder: I've been an investor -- and a subscriber -- since 2002.

However, it's easy to see how a chain of unfortunate events can trigger a downfall in a stock that was richly priced at its peak.

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Even after the plunge, it's not as if Netflix is a screaming bargain. Trading at 28 times this year's projected profitability and 19 times next year's bottom-line target isn't so cheap given the uncertainty of Netflix's model.

If subscribers continue to defect, as they will this quarter, it's going to get ugly. Netflix pays a flat fee to studios for years of streaming rights. This was welcome math when its subscriber base was expanding rapidly, but the numbers won't be as kind going the other way. Analysts will also naturally revisit their estimates if the downward trend continues, pushing up those earnings multiples.

The Qwikster move will be a challenge, even if it's pushed through as seamlessly as possible. It will inconvenience half of Netflix's subscribers, and they'll be tempted to start afresh through the growing number of alternatives that are now available.
There was less risk for investors in owning a well-loved Netflix at $300 two months ago than there is in owning a highly dissed Netflix at $130 today -- and we know how badly that played out.

Longtime Motley Fool contributor Rick Munarriz owns shares of Netflix, but of no other stocks in this article. Motley Fool newsletter services have recommended buying shares of Netflix. Motley Fool newsletter services have recommended buying puts in Netflix.