Netflix, Inc. (NASDAQ:NFLX) bagged the big cheese in kiddie TV and now Amazon.com, Inc. (NASDAQ:AMZN) has grabbed Nickelodeon’s preschool shows. Exclusive deals are heating up the race for share in Internet TV.
Picky, picky
When streaming video over the Internet was first getting started, Netflix, Inc. (NASDAQ:NFLX) and Amazon.com, Inc. (NASDAQ:AMZN) were in an arms race to have the most content. It only mattered how many hours of content was available. That helped spur adoption of the Internet as a video watching medium, but left both companies with content that was of little value.
Netflix, Inc. (NASDAQ:NFLX) has since begun to get picky. For example, the company’s first-quarter news release included this quote: “As we continue to focus on exclusive and curated content, our willingness to pay for non-exclusive, bulk content deals declines.” Netflix, Inc. (NASDAQ:NFLX) took a hard line with Viacom, Inc. (NASDAQ:VIAB) on this front, as it was willing to let a content deal expire over the ability to be selective about what it was getting.
Competition
With that as a backdrop, Viacom, Inc. (NASDAQ:VIAB) inked an exclusive deal for some of its Nickelodeon content with Amazon.com, Inc. (NASDAQ:AMZN). That bolsters Amazon.com, Inc. (NASDAQ:AMZN)’s place with the younger kid set. However, that’s not a major blow to Netflix, Inc. (NASDAQ:NFLX), which recently signed an exclusive deal with The Walt Disney Company (NYSE:DIS) for content.
These two deals show how intense the competition for content is getting. In fact, Amazon.com, Inc. (NASDAQ:AMZN) and Netflix, Inc. (NASDAQ:NFLX) are both creating their own content, too, in an attempt to differentiate their offerings. Investors, however, have to be careful in this arms race. Content is expensive and the content owners are the ones who are more likely to win than the ones distributing it.
Expensive stocks
For example, despite the increasing fight for content, Netflix’s trailing price to earnings ratio is over 500. Its forward P/E is in the 70 range. A company needs a lot of growth to support numbers like these. Although the top line has been advancing nicely in recent years, spending on growth led the bottom line to fall from over $4 a share in 2011 to about $0.30 in 2012.
If the company has to keep spending like that to support top line growth, the bottom line could be weak for years. With sky-high valuations, it won’t take much for investors to send the shares lower. Look to take some money off the table here.
More than prime
Amazon.com, Inc. (NASDAQ:AMZN) is much more than just its Prime shipping and video streaming service. So, this one business alone won’t make or break the company. However, like Netflix, growth spending has taken a notable toll on profits. In fact, earnings were in the red in 2012 after a long stretch of profitability. There’s no question that Amazon has a real business, but with the shares near all-time highs, investors would be well advised to book some profits.
Content
Content owners, meanwhile, have an increasingly interesting position in the world. Although the Internet has potentially hurt some sources of revenue, such as DVD sales, it has opened up another– digital content distribution. That’s not a bad trade-off, since DVD sales tend to be lumpy and content deals are more like an annuity.
The Walt Disney Company (NYSE:DIS) has a massive collection of content that just keeps getting better via acquisitions. The Marvel and Lucas Films deals are the most notable content purchases. That’s on top of Disney’s core collection of characters and familiar favorites.
Disney shares are almost always afforded a premium. So investors shouldn’t rush to jump aboard. However, with a top line that’s grown pretty steadily for a decade and a bottom line that’s advanced from $0.60 a share to $3.10 over that span, it is worth keeping Disney on your watch list. The trailing P/E here is around 20, not cheap, but not unreasonable. Watch for the P/E to drop closer to 15 and a yield in the 1.5% to 2% range.
Second tier
Viacom, meanwhile, also has a vast collection of video content to offer. That said, Nickelodeon, which is a major contributor to the company’s top and bottom lines, has been having a hard time over the last few years moving beyond some of its aging shows, like Sponge Bob Square Pants. That’s part of the reason why the company’s trailing P/E is around 16.
A lower valuation, however, doesn’t inherently make it a buy right now. More aggressive investors might take the Amazon deal as a sign of things to come and consider a purchase. However, most should watch from the sidelines for a price decline into at least the low $50s.
Hot market
The market for content is heating up. Rising costs are likely to be an issue for companies like Netflix, and makes valuations look stretched. That said, content companies have been hot, too. Longer-term, content looks like a better place to be, but it’s important to buy good content at the right price. Disney is among the best, but a pullback is needed before it is a good buy again.
The television landscape is changing quickly, with new entrants like Netflix and Amazon.com disrupting traditional networks.
The article The Internet TV Race Is Heating Up originally appeared on Fool.com.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Netflix, and Walt Disney (NYSE:DIS). The Motley Fool owns shares of Amazon.com, Netflix, and Walt Disney. Reuben is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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