WSJ Puts A SELL On Netflix

DVD rental service Netflix has been a big recession winner. Since November, shares have more than doubled, and Netflix (NFLX) is trading at a higher multiple than Apple (AAPL) or Google (GOOG). But is Netflix’s “stock-price bubble” close to “bursting,” as the WSJ’s Martin Peers argues?

The gist of his argument: Netflix’s stock gains are on steroids thanks to excitement around its DVD streaming service and Blockbuster’s (BBI) troubles. “Investors may be getting ahead of themselves,” Peers writes.

Meanwhile, besides increasing competition from ad-supported streaming services (and even from studios like Disney), Peers thinks Netflix’s success “almost guarantees that studios will look to renegotiate Netflix’s content-supply deals on tougher terms.” That suggests that Netflix could see its margins drop, which could spook investors.

Well, maybe.

But of course streaming costs are going to go up. No one is basing Netflix’s future online content costs on what it’s doing today — because Netflix isn’t licensing many big-name movies for its streaming service yet. The stuff you can watch instantly on Netflix today is mostly old, “catalogue” content that studios can’t even give away for free. Indeed, the company has already said it plans to “substantially increase” spending on streaming content in 2009, and that’s baked into its guidance. (Which was above consensus when announced in January.)

And the argument that competition from ad-supported startups will burn Netflix is still overblown, so far. We’re sceptical that studios are going to jeopardize their relationship with Netflix — which provides real revenue, especially from DVD rentals — to favour ad-based Internet streaming rivals, which generate a laughably small amount of revenue.

Specifically, the fact that Netflix’s business is based on subscriber fees means there’s actual money to exchange. Internet ad revenue sharing deals offer no guarantees, and so far, haven’t made much money for anyone. Studios know that. So while studios may offer some content to ad-supported upstarts, they may not offer the kind of quality content they’d sell to Netflix or other services that will actually pay them. And that’s what people want to watch.

If Netflix has anyone to worry about, we think it’s the cable industry, where giants like Comcast (CMCSA) and Time Warner Cable (TWC) have established, significant deals with studios, dedicated pipes into living rooms, and digital set-top boxes hooked up to tens of millions of TVs. They’re the ones with real, multi-billion-dollar businesses to lose, and they’re the ones that are going to be pushing stronger on-demand movie services that could pummel Netflix.

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