Digital envelopes may cost Netflix
EmptyThe cost of creating a digitally delivered movie service and competition from Blockbuster Inc. could depress shares of Netflix Inc. during the next year, according to a Bank of America analyst who advised clients Thursday to steer clear of Netflix stock.
In a 55-page report, analyst Brian Pitz initiated Netflix with a "sell" rating and $24 price target, 13.5% lower than where shares closed Thursday.
He said the $40 million that Netflix intends to spend next year to develop a movie download service to rival Amazon's Unbox, Apple Computer's iTunes, CinemaNow and others, might not be enough. Pitz estimates, for example, that it cost Amazon $42 million-$64 million to develop Unbox.
While Netflix CEO Reed Hastings predicts it will be as many as five years before digital downloads threatens the Netflix DVD subscription model, Pitz predicts meaningful competition from technologies a couple years earlier than that.
Pitz also noted that Netflix will spend 23% of its revenue this year in marketing, up from 18% in 2003, due in part to competition from Blockbuster, which is marketing its rival DVD-by-mail service at its stores and giving free movies to Netflix subscribers in an effort to woo them to Blockbuster Total Access.
"Netflix has indicated that it will continue to invest aggressively in acquiring new subscribers, and we believe this could adversely impact margins," Pitz said.
Shares of Netflix fell 2.3% on Thursday to $27.76, while shares of Blockbuster rose 2.5% to $5.41.
The analyst, while acknowledging that Netflix thus far has been adding subscribers at a healthier clip than many on Wall Street anticipated, expressed doubts that the company will reach its stated goal of 20 million subs sometime between 2010-2012. At year's end, Netflix will have about 6.3 million subs compared with about 2 million by year's end for Blockbuster.
The analyst also calls Netflix's Red Envelope Entertainment content division an "area of uncertainty." Through Red Envelope, Netflix has become the distributor for more than 100 independent movies, acquiring four new titles at January's Sundance Film Festival.
"While we recognize that growing its content library methodically can yield dividends in terms of average revenue per subscriber," Pitz said, "it is not clear that Netflix has a competitive advantage at picking films that will be winners."
The analyst notes, however, that Netflix has had success with such films as "Nice Guys Sleep Alone" and "Born Into Brothels," the latter of which won the 2005 Oscar for best documentary.
Pitz said Netflix's effort to produce some original movies "potentially puts it into direct competition with studios as well as cable TV players," a risky proposition that should "be watched carefully by investors."