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Netflix vs. Facebook: Why Netflix Won't Win the War

Netflix has been a darling of Wall Street for years, but the romance has cooled off suddenly and emphatically. The stock (NFLX) reached $247.55 on Valentine's Day - seems appropriate - and fell below $189 over the next 17 trading days, before recouping about half of the loss, much of it on Tuesday after Netflix announced plans to stream original content in the form of a Kevin Spacey TV series.

The catalyst for the selling appears to be concern over plans mooted by other companies - the most notable name mentioned is Facebook; (AMZN) is another - to compete with Netflix in offering streaming video.

We've been here before. One of the hallmarks of technology is that an innovative company can appear out of nowhere with a new product or service, changing an industry or creating a whole new one. The shooting star will expand massively in a short time and put purveyors of older, 1.0 tech on the back foot or out of business altogether.

The problem is that investors often become so captivated with the new company offering the latest thing that they neglect to realize that innovation isn't going to stop and that some other sharp operator can come along at any time and change the game again or at least beat the incumbent at it. All of a sudden their hot stock is yesterday's news.

As Kevin Landis, a veteran Silicon Valley fund manager who often gives his views to MoneyWatch, such as here, here and here, points out, by the time you're sure that a tech company has a solid, long-term competitive edge, it probably doesn't. That contrasts with the initial months and years when opportunities are many and certainties are few.

When he bought Netflix in 2003 in the high teens, he recalls, skepticism toward its business model - delivering videos through the mail - was rampant. "I can't tell you how many versions of the same two or three bear stories came out about this stock," he remarked. The mood had changed completely by the time he sold Netflix when it made an earlier pass through $200.

"It's always a tricky puzzle to figure out what's going to be a stable, sustainable advantage," said Landis, manager of the strongly performing Firsthand Technology Opportunities Fund (TEFQX). "Every time you invest in a first-mover, innovative company opening a market, you're trying to solve that puzzle in real time. Netflix went from being an obscure, misunderstood stock to being everyone's favorite company - the model for next-generation entertainment delivery. That's kind of a scary thing."

The ubiquitous praise was one of the things that scared him out of Netflix, although he confesses that he still likes the company, if not the stock. "It's going to remain one of the strongest brands in the space," he predicted. "Part of it depends on the persistence of people using DVDs. I love new technology, but I'm perfectly fine using old tech if it works and it's convenient. Netflix has a huge advantage as long as people keep doing that."

Consumer choice is important, Landis said, and Netflix will continue to benefit for a while by giving consumers the option of receiving their videos by mail or streamed through one device or another. Still, streaming delivery is in the ascendancy, and it's the growing choice that consumers have when it comes to the electronic delivery of their content that worries Landis. Facebook and are high-profile, eyebrow-raising entrants into the field, but there are many others. (Speaking of choice, Landis wonders if Facebook users will be given access to "The Social Network.")

It remains to be seen whether Netflix can attract enough new business to justify the $100 million that it is thought to be shelling out for the first-run rights to the Kevin Spacey series, called "House of Cards" (you can't make this stuff up). It sounds like a lot of cash to risk on an experimental venture.

A war has broken out among the myriad distribution channels, with content providers serving as the arms dealers who profit by selling to all sides. As long as that war rages, Landis will be happy to remain neutral. He has no plans yet to get back into Netflix.

Come back Tuesday as Landis expands on his analysis of the companies distributing entertainment and his argument that investors should avoid them. There's no shortage of choices here, either. There are plenty of stocks that he thinks could be a Netflix waiting to happen.

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