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Netflix: A Strong 'Buy' For 2012 And Beyond

When one thinks of video rental innovation, it's impossible not to tell the story of Netflix (NASDAQ:NFLX). Ever since the creation of its subscription-based digital distribution service in 1999, the market for video rentals has been turned upside-down. For better or worse, Netflix has been predominantly responsible for the traditional video store's demise.

Netflix was founded in 1997 on the idea "why pay late fees?" and has been evolving ever since. By 2009, it had over 100,000 different DVD titles and 10 million subscribers. Two years later, at the end of 2011 - and as a direct result of the declining market of DVD rental stores - Netflix had over 24 million subscribers and a revenue increase of nearly 50% from the previous year.

While the future seems bright for Netflix, 2011 was a rocky year. Netflix CEO Reed Hastings was blasted last year by die-hard subscribers for price spikes and the September announcement of a new sister company: Qwikster. He quickly came out and apologized for splitting Netflix into two offshoots: Netflix for streaming and Qwikster for DVDs by mail. Qwikster was thereby cancelled. The 60% price hike, however, remained.

The summer's price hike was enough to deter 800,000 subscribers, or roughly 3%. After weathering the storm, Netflix was able to end the 2011 fiscal year on a bit of a high note as it gained 600,000 new subscribers. While the stock is trading well below its July 2011 peak of $305, its current price of $122 is up 70% since the start of the 2012 fiscal year.

So where does Netflix go from here? Now that the Internet forum outcries from Qwikster and the price hikes have settled, Netflix will refocus on delivering a high-quality product and fending off competition.

This is backed by the recent announcement that next year Netflix will be offering an original horror series, Hemlock Grove, starring Bill Skarsgard. The ensuing 4.4% stock increase represents the resulting investor satisfaction. In February of this year, The Weinstein Company and Netflix agreed to a multiple-year licensing agreement that includes exclusive rights to certain movies. Netflix also has licensing deals with Relativity Media, Dreamworks Animation (starting in 2013), Open Road Films, Epix, FilmDistrict, and Starz.

Many industry experts, however, say the future of video rentals lies in streaming and "instant watch" devices. Many new tablets, Wi-Fi-enabled TVs, and gaming consoles offer the ability to stream movies, music, and TV shows via the Internet. Netflix and its competitors have jumped on this bandwagon.

A new user to the video streaming world has a few things to consider. First, are movies and TV shows equally important? If TV shows are what you want, Hulu Plus (owned by a contingent of major television corporations) is a valid consideration. While Netflix also provides some TV shows, Hulu Plus - at $8/month - is the premier choice for current-season episodes. Hulu Plus, however, has its fair share of limitations. Viewers have to sit through mid-episode commercials despite the monthly fee, and the number of titles in the movie selection has yet to reach the 1,000 mark. While heading in the right direction, Hulu Plus clearly seems more interested in serving those who are looking for in-depth access to favorite TV shows, rather than seriously challenging Netflix on the movie-side of the market.

Another option is Blockbuster Total Access. For $9.99/month you receive the same DVD-by-mail service that Netflix offers, but with the option of grocery store kiosks and in-store exchanges. Blockbuster also claims to have a wider selection of movies and earlier release dates then Netflix. These features sound great if you live near a Blockbuster store, but, based on the September 2010 bankruptcy, you probably don't. Blockbuster has recently teamed up with Dish Network (NASDAQ:DISH) to provide some streaming, but users only benefit if they already have Dish service. By pursuing a streaming feature, Blockbuster seems to be heading in the right direction. The mirroring of both Netflix and Redbox, owned by Coinstar (NASDAQ:CSTR), however, and thereby lack of innovation, should have future investors worried.

Which brings me to my next Netflix competitor: Redbox. Even though Redbox has been around for 10 years, its market share has only gained ground in the past few years. Redbox best serves those who rent movies more spontaneously and don't want a monthly payment commitment. Redbox currently has automated retail kiosks in over 27,000 locations across the U.S. and rents its discs for a little over $1/day. While selection of movies and video games is limited, Redbox carries newer releases then Netflix. However, it is on a first-come, first-served basis, and has yet to delve into online content. While fairly innovative, Redbox has its limitations and is better suited for the "light" movie watcher.

Amazon (NASDAQ:AMZN) is another company trying to cash in on the movie streaming market. Its service, Amazon Prime, was launched in 2005 but didn't include a rental service until February 2011. Amazon Prime is a yearly service, about $80/year, and offers a limited "free" selection (included in yearly membership) of movies and TV for instant streaming. Most newer, popular titles are available to rent or buy at an extra cost. While available on an array of devices, Amazon Prime is still in its infant stage and lacks the breadth of titles currently found on Netflix.

It is also worth noting other players looking to gain a foothold in the movie rental market. Heavyweights Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG) have reportedly been looking to develop products that willchange the way we watch TV. Whether or not an Apple TV plus iTunes will rival Netflix is yet to be seen. As for Google, it currently has its technology available on a Sony line of TVs, but it is relatively new and offers access to the Netflix app. It will be worth watching how this develops in the next few years.

So where does Netflix go from here? It is difficult to say for sure, but I think Netflix will go where the future of movie rentals goes. Or vice versa. Unlike its competitors, Netflix is well prepared to handle change in movie-watching habits. If the popularity of hard-copy DVDs sticks around for a while, Netflix has flexed its muscles in that market before. If the online streaming trend continues upward, Netflix is currently available on a plethora of Smart TVs, mobile devices, and gaming consoles.

Netflix has shown that it can recognize and overcome diversity (price hikes and Qwikster failure) and I think they are the best bet for separating themselves from the pack. They have leadership that admits it when they're wrong, the best overall selection of movies and TV shows, a flexible (you can pause your account if, say, you go on vacation) and reasonable monthly plan, and best business model going forward. I like Netflix in 2012 and beyond.

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