More Tailwinds for Netflix
Nat Worden
06/27/05 - 02:56 PM EDT
Netflix (NFLX Quote) shares got a boost Monday as Wall Street speculated that a key competitor is about to enact a price increase.
Thomas Weisel Partners analyst Gordon Hodges said in a research note that shares of the online DVD rental company could see upside if
Blockbuster (BBI Quote) is forced to raise the price on its DVD-by-mail service.
"We believe the competitive environment may improve faster than earlier expected as Blockbuster appears to be tinkering with pricing and already implementing price increases through a variety of offers," Hodges wrote. His firm makes a market in Netflix shares and has an investment banking relationship with the company.
Shares of Netflix were recently up 35 cents, or 3.2%, to $16.12. Hodges said the stock could rise to around $23 in the event of a price increase. Meanwhile, Blockbuster, the movie rental giant that was slow to enter the online-subscription game, was trading down 11 cents, or 1.2%, to $9.04.
Currently, Blockbuster's standard online service costs $14.99 a month. That's a 20% discount to Netflix's price of $17.99 a month. Furthermore, Blockbuster has launched an aggressive marketing campaign to lure customers. Despite all this, Netflix remains the market leader, and Pacific Growth Equities analyst Derek Brown estimated that it is adding new subscribers at about the same pace at its deep-pocketed rival.
Brown noted that Netflix added 789,000 subscribers in the fourth quarter of 2004 and the first quarter of 2005 combined. That performance surpasses its number of new subscribers added in all of 2003 and in any two consecutive quarters in the company's seven-year history. By comparison, Blockbuster claims it added 750,000 subscribers between mid-August and halfway through the first quarter. It plans to have amassed a cumulative total of 1 million subscribers by the end of this year, compared with Netflix's estimate of 4 million.
"The worst of the competitive storm appears to have passed for Netflix, and its business remains fully intact," Brown said. His firm makes a market in shares of Netflix, but it does not have an investment banking relationship with the company. "That's not to say that it's going to be a perfectly smooth ride for this company, but things look favorable at this point."
Adding to Netflix's favorable outlook, analysts agree that at some point, Blockbuster will raise prices.
"It's not really a question of will they raise prices -- it's more a question of when," said Dennis McAlpine, an analyst with McAlpine & Associates. He doesn't own shares of Netflix and his firm has no investment banking relationship with the company. "If we can trust the numbers that Netflix has shown us, it doesn't seem like Blockbuster could be making any money at these prices."
In the past, Blockbuster has made it clear it's willing to accept losses in an attempt to get a foothold in the online subscription DVD business. However, the new formation of its board at the hands of activist investor Carl Icahn suggests that the company may shift its focus toward profitability and cash flow. That might involve a price increase on its DVD subscription service.
In his note, Hodges noted that Blockbuster already has been testing a $17.99-a-month subscription price in isolated instances. After
Wal-Mart (WMT Quote) bowed out of the race and handed its subscribers over to Netflix, Blockbuster offered to match its offer with the inducement of two free DVDs, an offer that Hodges called a "veiled price increase."
Also, Hodges recently observed
Yahoo! (YHOO Quote) home-page ads for Blockbuster's service for $4.99 a month. Reading the fine print, he discovered this offer was actually replacing a 30-day free trial offer with a first month discounted to $4.99.
If Blockbuster opts for an official price hike, or even if it simply tones down its marketing push, Netflix stands to benefit.
In a recent survey conducted by Foresee Results, a customer satisfaction consultancy, Netflix was named as "the cream of the crop in customer satisfaction" among 40 of the top Internet retailing sites, including
Amazon (AMZN Quote),
LL Bean and
Apple (AAPL Quote).
Meanwhile, Amazon remains the wild card in the business. Speculation has run rampant that the online retailing giant will enter the market, partnering with Netflix or Blockbuster, or just launching a service of its own.
Amazon, which has already started online rental services in Europe, has held talks with both players about a partnership, but nobody is commenting on the substance. Still, analysts are willing to bet that as the market leader, Netflix would be the more likely beneficiary of any move Amazon might take.
McAlpine said NetFlix has been downplaying the future threats to its business model posed by new technologies like video-on-demand.
"They don't seem to think it's a very big deal anymore," McAlpine said. "If they're right, that gives them more credibility as a long-term stock investment, and it will save them a lot of money in research and development costs."
