Avoid Netflix — It’s a Value Trap!

After management gave a dismal view of the future Monday, Netflix (NASDAQ: NFLX
) shares tumbled 35% Tuesday. Although revenues actually were 49% higher for the
quarter, the combination of rising fees to TV and movie studios and
higher-than-expected customer defections led the company to forecast losses for
the next year. Alas, such is the fate of a fallen glamour stock. My words
yesterday about the beleaguered Netflix were, unfortunately, prophetic. I wrote,
Chasing trendy stocks is a risky business. Consider the case of Netflix. Earlier
this year, the former growth stock darling could do no wrong. The company that
put Blockbuster into bankruptcy with its DVD-by-mail business was aggressively
expanding its Internet streaming offering. But why anyone would pay a premium
multiple for the stock was a mystery to me. The company had no competitive
advantage, or what Warren Buffett likes to call "moats." Netflix is not
Coca-Cola (NYSE: KO ). Unlike Coke, it does not have an indestructible brand
that can withstand a very bad miscalculation by management. Coca-Cola could
survive something as idiotic as New Coke, a major product upheaval that
customers neither wanted nor needed. Netflix, however, might never fully recover
from its premature decision to cut the DVD-by-mail business loose. It wasn't
always that way. For a brief window of time, Netflix did appear to have a
competitive advantage. The DVD-by-mail business was a quirky idea that just
happened to have perfect timing and, once established, was very expensive for a
would-be competitor to replicate. Alas, it wasn't durable; it had a very
finite shelf life. In the late 1990s, streaming video still was in its infancy
and was not ready for the mass market. Too few Americans had broadband
connections, and even if they did, they lacked access to Internet-ready TVs and
DVD players. And again, even if they had such devices, movie studios were not
yet prepared to make their content available over the Internet. Movie watchers
still were dependent on physical media, and for those who liked the convenience
of home delivery, the DVD-by-mail service was a perfect fit. Today, a decade
later, it seemed anachronistic and almost quaint to physically mail something
that can be quickly delivered digitally; this is the age of the iTunes song and
the Kindle e-book. Netflix's management realized this and was right to
de-emphasize the DVD-by-mail business and corral its customers into the Internet
streaming service. But the move to split the company into two separate sites
and dramatically raise prices in the process was moving too far too fast. And
with no competitive moat to prevent customers from going to rival services like
Hulu Plus or Amazon s (NASDAQ: AMZN ) Amazon Prime, Netflix suddenly looks very
vulnerable .