Why We All Overreacted To Netflix

Have you chosen sides yet in the Great Netflix (NASDAQ: NFLX ) Debate of 2011?
Do you hail CEO Reed Hastings as a far-seeing prophet of online video? Or are
you appalled at the madness that led one of the webs biggest successes to
declare that the customer is not always right? Or are you, like me, shaking your
head at the whole stupid debate? The simple truth is that Netflix is pinning its
future on streaming media, and doing what it has to do to get there. In the
process, its botching the transition from DVD-by-mail to pure streaming in a way
that will cause it headaches for some time. Both views have some merit, but both
are overreacting. So how do investors respond? Trading strategies in Netflix
used to be so simple. You either thought it would be crushed under the wheels of
a traditional giant like Blockbuster, or you believed it would prove naysayers
wrong. And in that halcyon past, the longer a bull stayed long in Netflix, the
more that bull won. When all the emotion of the present moment passes, there
will be several factors suggesting the company is making the hard choices
necessary for its survival, and also several clear things that it screwed up.
Here are a few of each: Netflix is Being Dumb 1. A search too far. When Hastings
made his murky and vilified defense of the move to separate DVDs by mail and
streaming video, someone asked in the comments whether hed need to search twice
for the same movie, Hastings responded ouch as in, yes, youre right. To me,
that means we didnt think this through right (unlikely) or we know and just dont
care (likely). 2. The branding fail. Qwikster, the new name for Netflix's DVD
business, is not only easily confused with Quickster (a collapsible Lacrosse
net) and Qwixtar (an Amway business), its slang for a guy who can get women in
bed quickly. That ones going down in the annals of bad branding. Netflix Is
Being Smart 1. Nobody outside the U.S. is complaining. This is the thing the
critics don't want to say. If millions of U.S. subscribers fall from Qwikster,
thats great news for the neighborhood video store. But its not bad news for
Netflix, if angering tens of millions of U.S. subscribers is offset by the
addition of a hundred million in Latin America, Europe and Asia. In that case,
Qwikster will be an unsightly footnote in the companys history. 2. The power of
scale. Start the countdown until Qwikster is sold off. Theres simply no more
growth in it, and without new subscribers Netflix has no leverage in pricing
with the big studios. But by getting subscribers in other countries before
rivals do, Netflix can scale up its subscriber base into a juggernaut that would
make even the most clueless studio executive sit down at the bargaining table.
Qwikster may be Netflixs childhood, but the company is lurching into adulthood
and not looking back. What does all this add up to for investors? Netflix has
always had a gift for seeing, several years ahead of anyone else, where the
video-rental industry is heading. Until now, its managed to pursue that vision
by giving consumers what they want. Now, its pursuing its vision by denying
consumers (U.S. consumers, at least) what they want. That means Netflix is going
to be rather volatile for a while: a risky investment in the short term. Its
likely to fall further as U.S. cancellations pull down revenue and licensing
fees push up costs. But once streaming subscriptions start to accelerate
internationally, it will surprise the bears and rebound sharply. No longer is
investing in Netflix simply a matter of going long and watching it prove the
naysayers wrong. Like everything else in the stock market these days, investing
in Netflix is a matter of shrewd timing.