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Netflix: Customers Satisfied, But Will It Solve The Real Problem?

 October 05, 2012 01:04 PM

(By Mani) Shares of Netflix, Inc. (NASDAQ: NFLX) were up 20 percent in the past five days, driven by a survey by Citigroup that showed an improvement in the overall customer satisfaction. However, Netflix still faces some problems, which are explained in later paragraphs.

Meanwhile, the survey showed that 48 percent of Netflix's current subscribers are very or extremely satisfied compared to 44 percent to 45 percent levels observed in the first and second quarter of 2012.

Customer satisfaction is not an issue with Netflix, barring last September's price increase triggering mass defections and trade downs, and tarnishing the attractiveness of the service to new customers.

[Related -Netflix, Inc. (NFLX) Q4 Earnings Preview: What To Watch?]

Netflix still is the leading player streaming and DVD rental businesses due to its impressive content library and superior video quality despite budding competitors such as Amazon (NASDAQ: AMZN), Dish Network (NASDAQ: DISH) Blockbuster and Comcast (NASDAQ: CMCSA).

The real problem for Netflix is the rising content costs and increasing competition. For instance, Netflix streaming content costs could increase by an estimated $200 million to $400 million annually, and the rising content costs would pressure margins. Due to higher costs, Netflix already dumped Starz, lost Epix exclusivity, and just recently lost content from A&E and the History Channel.

[Related -Netflix, Inc. (NASDAQ:NFLX): Can Netflix Trump Amazon.com, Inc. With New Plans?]

Creating original content would be a cheaper and effective alternative, and Netflix is doing just that.

The Netflix, which has 27 million streaming members, said its original series, from Media Rights Capital, "House of Cards," will be available for members to watch instantly beginning February 1, 2013. The drama's second season is due to begin production in spring 2013.

However, competitors are not going to be silent while new competition is emerging at a rapid rate. Netflix could face a stiff test during the holiday period when it needs to rival a partnership between Verizon Communications Inc.'s (NYSE: VZ) online venture with Coinstar Inc.'s (NASDAQ: CSTR) Redbox. In addition, online retail giant Amazon.com Inc. (NASDAQ: AMZN) has been rapidly adding content to its Prime streaming service, too.

Moreover, it faces tough competition from Google's (NASDAQ: GOOG) YouTube and Apple's (NASDAQ: AAPL) iTunes as they have provided competition on the pay-as-you-go front. Hulu has provided a subscription alternative for "new" television, and its existence caused the television networks to revisit the value of their content in the over-the-top Internet streaming market.

The latest to enter in the digital entertainment space is Toys"R"Us, Inc., which has launched Toys"R"Us Movies, a brand-new digital entertainment service that provides families instant access to the movies and TV shows. Available at ToysrusMovies.com, the service features more than 4,000 titles and no subscription required.

Users will be able to stream content available on ToysrusMovies.com on PCs, Macs and Adobe Flash-enabled devices. The company will expand the service to additional web-enabled devices in the coming months, including Blu-ray players, televisions, tablets and more. High-definition content will also be made available in the near future. Later this fall, Toys"R"Us Movies will launch on dedicated iOS and Android apps.

Movies start at $2.99 for a 24-hour rental and at $5.99 for a licensed digital download or stream. Television shows start at $0.99, with the majority priced at $1.99. In addition, it Toys "R"' US is launching its own $149.99 tablet, which will go on sale Oct.21.

iStock's View: Investors should exercise caution with Netflix, which is one of the most volatile and unpredictable stocks in the entertainment space as its fundamentals still need to entice investors. The company is expected to go breakeven this year, compared to a profit of $4.26 a share in 2011. Moreover, barring Toys"R"Us, all of its competitors have deep pockets and have solid customer base in their respective main businesses, making them powerful rivals in the future.

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