My new "technopundit" buddy, Phil Simon and I had a discussion yesterday about Netflix and their recent follies.  Our discussion revolved around the fact that I didn't think it really mattered much that Netflix raised their prices, nor that they were going to spilt the company in two.  I was in favor of their splitting the company and focusing on the future of their business which is in streaming.

Yes, they lost some customers and yes, they got a ton of complaints.  The reality is that anytime you make bold moves, you're going to upset some people. Anyone remember when Apple decided to leave disk drives out of their Macs? I think the reaction to the backlash was worse than the backlash itself.

Phil shared an interesting and timely article with me which came out today based upon some of the things we discussed just yesterday about Netflix.  In fact, the article, Ideas aplenty on how Netflix could win back customers, had quoted him.  

Phil raises a good question in the article about whether or not Netflix can regain customer trust.  Others were quoted with their suggestions on what Netflix needs to do.  Unfortunately, I don't think any of those suggestions matter, nor would they rebuild trust because what Netflix did was more of a purge of certain customers that were price sensitive.  Furthermore, it was a separation of types of customers based upon usage.

Maybe There Was a Buying Opportunity

Because I was curious to see if Netflix might be a good potential investment under my new criteria, especially with all the negative talk about the company and its stock price getting hammered, a few days ago I peeked into Netflix's financial statements (Form 10-Q for the period ending 9/30/11).    Just to confirm my initial feeling, I decided to take another look today.  

This is by no means a recommendation one way or another to purchase or sell the stock and is just a cursory review of what I saw in my brief look at the numbers. Simply put, they have huge liabilities, mostly due to purchase of their content library.  What is key to their success going forward is whether or not the continuing investments they have to make in their content library and distribution deals are a sustainable business model.  And why the heck is a company that's investing in their future growth using much needed cash resources to buy back their stock?

Wait, There're More Reasons to Look Elsewhere

With DVDs, you can buy new DVDs and rent them as many times as you want without restriction.  With streaming, you typically have perceptual license agreements that can be pulled or not renewed such as what happened with Starz.  

This means that the price of their streaming service will need to increase significantly to sustain the costs that the content owners (studios) are wanting to charge.

Netflix actually needs the DVD business to subsidize the cost of content on the streaming side.  The streaming business itself is simply not feasible because they'd have to double or triple the price of it in order to make it self sustaining on its own at this point in time.  

The price increases they implemented had nothing to do with the price of mailing DVDs.  My feeling is that it had to do with the need to make more money to subsidize the cost of the streaming business.  Netflix realized that by separating the two, they'd have to segment reporting of each division.  This would show huge losses on the streaming side of the business.  

As a standalone company, a streaming only business would need a tremendous amount of financing, customers willing to pay significantly higher monthly fees and tighter relationships with the studios.  It's basically a startup at this point and not one with great short term prospects.

My household uses Netflix, both streaming and DVD by mail.  Our price for the service has been slowly creeping up for several years now anyway so another relatively minor price increase isn't really that big of a deal to us.  We are certainly fans of the service and recent negative press have no bearing on our commitment to continue using it.  

For many though, a threefold price increase may require us and many others to look for alternatives, certainly if the content library for streaming isn't as comprehensive as the DVD by mail service.

The biggest issue is that Netflix doesn't have the same type of influence and power as a company like Apple that's needed to disrupt the distribution of premium movie quality content.  Therefore, Netflix doesn't stand much of a chance as a standalone company in the streaming space.  It's unfortunate though because as a customer and potential investor, I'd like to see the company succeed.  However, now is a great time for a well positioned acquirer to scoop up the company at a much reduced price and use their muscle to get the studios to provide content at a business model friendly price.