The decline
After reaching a high of around $300 per share in July 2011, the stock began to nosedive. In that same month, Netflix, Inc. (NASDAQ:NFLX) restructured its pricing, upsetting many subscribers. The old $9.99 plan, which included DVD-rental and streaming, was split. This increased the total price of a combo-plan by about 60%. A few days later, the company announced that it was spitting its DVD business from its streaming business. The new DVD-only business, Qwikster, would have a separate queue from the streaming-only Netflix, Inc. (NASDAQ:NFLX).
The Qwikster plans were quickly scrapped after outrage from customers, but the price increases remained. The stock plummeted, and then things got even worse. The price increases caused Netflix, Inc. (NASDAQ:NFLX) to lose about 800,000 subscribers in the third quarter, sending the stock even lower.
The comeback
People tend to project recent trends into the future, and the subscriber losses in 2011 are a case of exactly that. However, at $300 per share before the decline, Netflix, Inc. (NASDAQ:NFLX) was trading at a nosebleed valuation, meaning that much of the decline was actually warranted.
Since the crash, the DVD business has been slowly bleeding subscribers as more people shift to pure streaming. Streaming subscribers are being consistently added, and the company is aggressively expanding into international markets. The company is creating its own content, and shows such as House of Cards and Orange Is the New Black have received critical acclaim.
The future
Netflix, Inc. (NASDAQ:NFLX)’s business model, paying for content to stream for a monthly fee, is not a great one. With competitors like Amazon Instant Video and Redbox Instant bidding for exclusive content, the price of licensing content from the owners will only get more expensive. Original content is the key, but with Netflix spending $100 million on developing House of Cards, for example, it’s questionable if that investment will pay off.
My fear is that high spending on licensing and content development will never stop, pushing down margins and preventing the company from ever becoming meaningfully profitable. Netflix traded at 80 times earnings in its best year, 2011, and it seems to me that the market is ignoring the effects of competition.
The bottom line
Both Best Buy and Netflix shares have surged this year as the companies have overcome their respective issues. Best Buy is still inexpensive after its run, while Netflix is a far riskier bet.
While Netflix could grow into a global media giant, the business model doesn’t really allow for outsize profits. If Netflix can control its costs as it develops exclusive content, then the company has a chance of developing a competitive advantage. But I have some serious doubts.
The article The 2 Biggest Comeback Stories of 2013 originally appeared on Fool.com and is written by Timothy Green.
Timothy Green owns shares of Best Buy. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix.
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