Is Netflix the next AOL?

@CNNMoneyTech October 28, 2011: 12:55 PM ET
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NEW YORK (CNNMoney) -- It still has millions of subscribers, generates a decent chunk of cash and is reporting solid sales growth, but the warning signs are there. If Netflix doesn't watch out, it could be the next AOL.

Netflix (NFLX) used to be Wall Street's favorite momentum tech stock. Not anymore. Shares have plunged 52% year-to-date, and with good reason.

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This isn't a case of Netflix not being able to live up to lofty expectations. It is facing serious challenges. Hence the AOL (AOL) comparison.

The significant price hike for customers that want access to both DVDs and online video streaming caused the faces of many consumers to turn redder than a Netflix envelope. Customers aren't just taking to Twitter and Facebook to complain: They are actually cutting ties with Netflix.

Netflix announced Monday that it lost about 800,000 subscribers in the third quarter. That is terrible news for a company that investors had been buying on the hope that subscriber growth would continue for a long time.

Price hikes may be necessary to deal with drastically increased costs. Netflix has to find a way to justify the money it spends on content licensing deals if it wants to still be able to offer its customers the movies and TV shows they want.

Netflix also has ambitious growth plans internationally, and said earlier this week that it will lose money for the next few quarters as a result.

Netflix needs to get in touch with customers' rage

It may also be the case that, for the long-term, it's better (i.e. more profitable) to have fewer subscribers paying more a month than continually adding customers that only sign up for the cheapest plans.

But I can't help think that the decision to raise prices so drastically -- $15.98 a month to have DVDs and streaming is a 60% jump -- is eerily similar to the moves AOL made in the early part of the 2000s. (Those Naughty Aughties!)

Of course, prices hikes weren't the only thing that hurt AOL. It languished for years as a subsidiary of Time Warner (TWX, Fortune 500). The 2001 AOL-Time Warner deal is still viewed as one of the worst corporate mergers ever. Time Warner, the parent company of CNNMoney, finally (and mercifully) spun-off AOL in 2009.

But just as AOL faced a major identity crisis while trying to morph from a stodgy 20th century Internet access company to a cool content provider -- one that lasts to this day -- Netflix also can't figure out what it wants to be when it grows up.

How else to explain Netflix's ill-fated decision to rebrand its DVD business Qwikster in September, only to hastily abandon the plan a few weeks later?

Now don't get me wrong. Netflix has a lot going for it, and the worst may be over for the stock in the short-term. Shares now trade at just 14 times 2012 earnings estimates. (Of course, those estimates may be still too high.)

When I asked my Twitter followers a few days ago if they thought Netflix would be the next AOL, several rushed to Netflix's defense.

Netflix now has a market value of just $4 billion. To put that in perspective, Twitter follower Jesse Houston pointed out that it's only $2 billion more than online music service Pandora (P), which has yet to make a profit.

"$NFLX has shown much more innovation than $AOL in recent history. That's the name of the game in media delivery," Houston tweeted.

Another follower, going by the handle of Aman Forallseasons, praised Netflix for spending to get the streaming rights for shows from AMC (AMCX) and the CW, as well as movies from DreamWorks Animation (DWA). (CW is a joint venture of Time Warner and CBS (CBS, Fortune 500).)

"Shelling out that much for content was their best move in months," Aman tweeted.

Netflix could also be a takeover target for one of the many Hollywood studios that have been sparring with Netflix and rival Redbox about release windows for movies.

Netflix and Amazon aren't as bad off as it seems

Interestingly, Redbox parent Coinstar (CSTR) is now facing a Netflix problem. The bargain DVD rental kiosk service announced Thursday that it was boosting prices from $1 to $1.20 for standard DVDs to deal with higher costs. Coinstar's shares fell 9% Friday.

And even some former Netflix bears have changed their tune. Hedge fund manager Whitney Tilson of T2 Partners was on CNBC earlier this week talking about how great a value the stock is.

Last year, Tilson engaged in a strange online debate with Netflix CEO Reed Hastings. Tilson posted on investing blog Seeking Alpha about why he was shorting Netflix shares. Hastings, unsurprisingly,took the opposite view about the stock.

But that hasn't stopped all the AOL comparisons. For all the Netflix bulls that I encountered on Twitter, there were some compelling arguments from the skeptics too.

Andy Meek had fun making light of one of the hit shows that's part of the AMC deal.

"Interesting that one of the recent content acquisitions is the Walking Dead. Maybe they had that on the brain," he tweeted.

And Anthony Cogo threw cold water on the notion that a major media company would buy Netflix.

"With so many networks and studios doing on demand now, Netflix will die," he tweeted.

That may be a bit hyperbolic. AOL, after all, is not dead. But it's a shell of what it once was. And if Netflix isn't careful, it may suffer the same fate.

Reader comment of the week! It may seem superfluous to feature another shout-out to a Buzz follower in a column based on Twitter feedback, but Netflix was hardly the only interesting business story this week.

That little deal hashed out in Brussels dominated the headlines this week. I tweeted Thursday about how European banks were surging and noted that you can't spell "euphoria" without "EU."

That was met with this contrarian gem by reader Richard Isacoff. He tweeted that "you can't spell "pneumonia" without an "eu" either. Well-played. But here's hoping that Europe has finally found a cure to its sovereign debt sickness.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks. To top of page

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