Netflix must ponder its endgame strategy
Was it really only 15 months ago when everyone loved Netflix? The stock had risen nearly eightfold during a two-year rally, CEO Reed Hastings was hailed as a game changer and was asked for the secrets of his success, and Netflix was on track to kill off cable and rule the new world of online video.
Today, the cable industry continues to thrive and Netflix is the one on the ropes. The company's stock dropped 12 percent Wednesday, marking a 80-percent decline from its record high of $304 a share back in July 2011. Netflix had a decent enough quarter, with revenue in line with analyst expectations and net profit nine cents a share higher. But the company warned that revenue in the current quarter will be weak in North America at a time when Netflix is spending heavily to expand into overseas markets.
Hastings spends less time these days musing on the secrets of success and more time explaining the challenges facing his company. It isn't that he has suddenly gone from being a genius to a floundering CEO. He's still the same executive who engineered Netflix, one who sees the company's success as something built over a number of years, not in a matter of quarters.
Hastings' view of Netflix future is not unlike a chess player's thinking, plotting several moves in advance and remaining patient until all the pieces are in place. Netflix has been negotiating costly licensing deals with content owners and expanding its streaming service to Canada, Europe, and Latin America. International subscribers rose 192 percent last quarter to 4.3 million, although the international business has yet to show a profit.
The problem with Netflix's long-term strategy isn't that it's unpopular with investors, it's that, given the increasingly competitive market for online video, Netflix may not have enough time to make all its moves. Every quarter seems to see fewer chess pieces for Hastings. Netflix's operating cash flow has been dwindling for several quarters, and was a negative $20 million last quarter. And if cash flows stay negative, as the company suggests they will, the most likely endgame for Netflix will be an acquisition by a bigger company.
For as long as Netflix has been around, Amazon has looked like a good fit for an M&A deal. Gina Keating's “Netflixed,” published this month, said that the two companies discussed an acquisition back in 1998 before it fell through. (Netflix has since denied this.) For years, Amazon's efforts to avoid paying state taxes made a purchase of Netflix difficult, since Netflix has operations in many states. But now Amazon is starting to collect taxes in more states.
Even before Netflix's earnings report, the speculation of an Amazon-Netflix marriage was heating up again this month. Amazon has about $5 billion in cash and short-term investments. Netflix has a market value of $3.3 billion. Netflix would fit into the content ecosystem that Amazon has been building for years, and its library of streaming movies would make the combination of Amazon Prime and the Kindle Fire an even more compelling option for consumers.
In the wake of stories about Netflix, others suggested possible mergers, such as Hulu, which is jointly owned by media giants Disney, News Corp., and Comcast. One of Netflix's biggest challenges is negotiating with content owners, and joining forces with another online-video service, especially one backed by media giants, could offer more leverage in these talks.
There are other names that often come up as potential suitors for Netflix: Comcast, which signaled its interest in video-streaming with a partnership with Coinstar; Apple and Google, which have tens of billions in cash, yet lack a strong offering for streaming movies and TV shows; and Microsoft, which could enhance the appeal of the Xbox with Netflix's library.
Of those, Microsoft seems like the least likely. Hastings recently stepped down from Microsoft's board, making Microsoft an unlikely suitor. Hastings said he stepped down to have more time to focus on Netflix, which makes sense. But it could also be a preliminary move if Netflix was in talks to be bought by a larger company.
Again, the who-will-buy-Netflix game is as old as Netflix itself. For now, all of this remains speculation and Hastings seems intent on playing out his long-term strategy to keep Netflix the king of streaming video. But one thing that isn't in question is that it's getting harder for Netflix to achieve this goal. There are too many well-financed competitors, and it may be a matter of time before one of them corners this king into an acquisition.
[Image credit: Matt Reinbold on Flickr]