Netflix Inc.'s Woes Might Be's Gain

With Netflix's third-quarter subscription growth failing to impress Wall Street, sparking a 25% stock loss, some might think Amazon too is experiencing trouble with its video streaming business. But in reality, Amazon has invested aggressively to improve its services and offers users a bundle of services for an annual price that is very competitive to Netflix services. In other words, Netflix's loss could be Amazon's gain.

Amazon gains ground with big investments
Netflix's stock sold off hard after the company reported earnings, adding just three million new subscribers during the quarter, well short of its guidance for nearly 3.7 million new subs. The disappointing performance has led many to ask whether Netflix is reaching its user peak, especially in the U.S., where Netflix services are being used by nearly a third of all households. 

However, there is also the possibility that increased competition is starting to take a toll on Netflix. Specifically, Amazon has made major strides in the last year to make its streaming service more competitive against Netflix.

Last year, Amazon spent more than $6.5 billion on technology and content costs related to its streaming service. So far in 2014, the company has completed a couple of large deals by partnering with HBO for an undisclosed amount. Wedbush analyst Michael Pachter reckons the annual price Netflix pays HBO to be somewhere around $200 million based on similar deals within the industry. 

Pachter also estimates that Amazon's license streaming content costs will increase $800 million in 2014 versus 2013. In addition, Amazon recently purchased live streaming company Twitch for nearly a billion dollars, further strengthening its diverse content.

Prime users are growing fast
That said, Amazon and Netflix operate different types of business models, as the former offers streaming services as part of its Prime membership. While Amazon does not provide specific Prime membership details, analysts at Bernstein Research estimate the company has 42 million Prime members, with 60% using its streaming service. 

Reportedly, Amazon's Prime service subscribers have grown at a 55% annualized rate since 2012, and despite recently upping its annual price from $79 to $99, research from CIRP indicates that 95% of users would "probably" or "definitely" renew their membership. Meanwhile, Netflix specifically blamed higher prices for its disappointing new user growth. 

The Amazon difference
All things considered, Amazon is spending boatloads of money on new content, and while Netflix only offers streaming services, Amazon bundles free shipping, music, and other services with Prime membership. Thus, Netflix's disappointing quarter might not be a reflection of the macro performance for streaming, but rather an indication that Amazon's Prime is picking up steam.

Currently, Netflix has over 53 million subscribers, but Amazon has resources Netflix does not.

During Netflix's third quarter, it noted content obligations rose $1.2 billion higher since the second quarter to $8.9 billion. This illustrates the rate at which content costs are rising for media-related companies.

While Amazon must contend with the same issue, it earned more than $20 billion in trailing-12-month gross profit. Netflix's gross profit of $1.3 billion in the same period is far less, meaning Netflix does not possess equal resources to contend with the rate of rising content costs, giving Amazon the advantage of making big investments that are hard for Netflix to match.

There's investment value in streaming
With that said, there is a lot at stake for whichever company eventually owns the streaming industry. Netflix is the market leader, and it has a market capitalization of more than $20 billion, which is well off its 52-week high of nearly $30 billion earlier this year. Meanwhile, Jefferies estimates that YouTube is worth up to $40 billion. 

In other words, if Amazon can establish itself as the streaming market leader, and not a second-tier service behind Netflix and YouTube, investors can estimate a valuation that compares to its two competitors. This would translate to 25% of Amazon's total market capitalization, making video services a very important component to the e-commerce giant's valuation.

Foolish thoughts
Amazon's Prime service has strong user growth, and it has persisted with little resentment among users following price hikes. In the meantime, price hikes seem to have a direct impact on Netflix's underlying user growth.

With all things considered, it appears that Netflix's poor earnings are not a reflection of Amazon's future in streaming. If anything, Netflix's struggles may have been tied to Amazon's Prime growth. Nonetheless, given the many bundled services Amazon offers, combined with its willingness to make big investments in content, it now appears that Netflix has a viable competitor for Internet streaming; Amazon is a dominant Internet company that could pose a threat in the long term. 

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The article Netflix Inc.'s Woes Might Be's Gain originally appeared on

Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends and Netflix. The Motley Fool owns shares of and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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