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Vinay Singh
Vinay Singh
Articles (229) 

Netflix's Cutting-Edge Programming Makes It a Solid Buy

June 06, 2014 | About:

Netflix (NASDAQ:NFLX) is working quickly to differentiate itself on the content front. One area in which it's locking up a leading position is kids' television. Competitors like Amazon's Prime service are going to find it increasingly hard to compete.

Video Streaming or Television?

The line between video streaming and television is quickly blurring. The difference was quite distinct before Netflix made the switch from focusing on mail delivery of DVDs to streaming movies online. Just a few short years later, however, the company is clearly looking to be an Internet television station.

The big turning point came when Netflix moved into content creation, with shows like Lilyhammer and House of Cards. Amazon quickly followed suit, with plans for its own unique content. But a few self-created shows weren't enough to differentiate Netflix, or Amazon, as a television station.


Netflix has also shifted away from bulk content deals, looking to lock up exclusive content that it believes will lure subscribers. To that end, it inked a deal with Disney for some of that company's kids-themed content. At the same time, however, it took a hard line with Viacom, letting a content deal expire over the ability to be selective about what it was getting.

Amazon jumped on that event and signed on for Nickelodeon content, boosting its position with the kiddie set. However, with Disney already on board, Netflix could afford to let Nickelodeon content slip away. That said, the Amazon Prime offering, which somewhat oddly pairs free shipping with video streaming, likely has enough to keep cost-conscious customers from jumping ship.

That's a win for Amazon, though maybe not for investors. Amazon's shares are trading near all-time highs despite razor-thin margins in the low single digits. While a growing top-line is impressive, investors will likely jump ship if the company doesn't figure out how to get margins back into the mid single-digits. Rising costs for content won't help that effort, though Prime is clearly only a small part of the company's overall business.

The Latest Deal

Netflix, meanwhile, has inked a forward-looking deal with DreamWorks Animation. While the Disney deal provides an archive of content, DreamWorks is going to create 300 hours of original content just for Netflix.

Disney and DreamWorks are two of the leading names in animation. Having locked both up in deals gives Netflix a huge advantage over the competition. While there is risk in paying DreamWorks to create untested content, the company has a proven track record of success with franchise-worthy hits like Shrek, Madagascar and Kung Fu Panda.

DreamWorks, meanwhile, has now found a new outlet for its content. That should help insulate it somewhat from the hit-or-miss movie business. And it creates another distribution partner to play off of to get more money for its content. This could help the company's top-line break out of its malaise in the $700 million area.

The shares have seen a large advance over the last few months, so they are most appropriate for momentum investors right now. That said, if it can use the Netflix deal to create more consistent and higher top- and bottom-line results, there is room for upside. Growth investors should keep an eye on this content creator.

Too Expensive

Netflix, for its part, jumped around 7% on the news of this deal. While the enthusiasm is justified, the deal just means the company is going to be paying even more for content. Rising content costs are a big issue to watch here and were a part of the reason for earnings falling from $4 a share in 2011 to $0.30 last year. Clearly there is a lot of potential, but not if the company has to keep paying more and more for content.

Netflix is differentiating itself well and has now established a dominant kiddie offering. However, investors should be concerned about its elevated price, over 500 trailing price to earnings ratio, and the real risk that investors sour on the shares if results can't keep up with expectations.

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