Netflix starting to take it in the shorts

Streaming Video What goes up must come down. After hitting an all-time high of $173  last month in the wake of the Blockbuster bankruptcy filing, shares of Netflix have begun to fall to earth. As of Friday’s close, the stock was off more than 10 percent from its peak. Short sellers are piling on. According to FactSet Research, short interest in Netflix shares has risen 64 percent since June and now represents roughly one-third of its float. UBS Securities and Susquehanna Research recently downgraded the stock.

High-flying stocks ofter provoke a backlash, and that’s no doubt part of what’s causing the shift in sentiment on NFLX. The shares are currently trading at 42X forward P/E and 63X trailing — sky-high even for a growth stock. But a more comprehensive bearish narrative has also emerged lately, which holds that as Netflix’s business shifts from mailing out DVDs to streaming it is increasingly exposed to direct competition from the likes of Amazon, Google,  Best Buy and Comcast, all of which have much larger financial resources than Netflix and generally operate in more favorable release windows. That will lead to slowed subscriber growth for Netflix, higher content acquisition costs, lower prices and ultimately margin compression, according to the bears.

Maybe so. I’m no stock picker. Shorting any stock trading at NFLX-like multiples is probably not a terrible bet. But I’m less convinced that Amazon, Google and the rest are as well-positioned competitively against Netflix as the bears seem to believe. For one thing, it’s a bit of an apples-to-oranges comparison. Much of Netflix’s value proposition is bound up in its being an all-you-can-eat subscription service rather than an a la carte transactional service. Most of Netflix’s would-be streaming competitors are focused on building transactional services. The two are very different use cases from the point of view of the consumer and neither is a perfect substitute for the other.

It’s possible Amazon or Best Buy could try to offer a competing subscription service, but that’s not as easy as it sounds for companies geared largely for transactional business models. Switching your orientation from maximizing profit-per-sale to maximizing revenue-per-user is not a trivial matter, especially for large corporations. The potential competitor best-positioned to pull it off is probably Apple, due to its large existing base of iTunes users. But for now, at least, Netflix and Apple are acting more like partners in Apple TV than competitors.

Netflix’s service-based value proposition also works to negate some of the downside from a less-favorable window. When Netflix started, it was less convenient than Blockbuster because users often had to wait three or four days for a movie to arrive in the mail. Yet Netflix succeeded while Blockbuster stumbled. That’s not to suggest Netflix wouldn’t prefer better access to new releases for its streaming service, but windows have not been particularly determinative to its success up to now.

Most importantly, Netflix has a substantial first-mover advantage over would-be competitors, not in offering streaming per se but in embedding its virtual storefront in connected devices. It has locked up deals with nearly all major CE makers and its app comes embedded on over 100 different types of devices. By the end of this year, it’s expected to be found on over 60 million total devices. As with brick-and-mortar retailing, market share in virtual retailing is partly a function of real estate. And Netflix already has a lot of prime locations locked up.

Further reading:

Google Says Web-Television Partners Include NBC, HBO, Twitter and Netflix

Don’t Be Mislead in This Valuation

Netflix Subscription-Fee Decline Slows