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Can Netflix stay on top?
Get out the popcorn: The online DVD renter faces a showdown with Blockbuster.
May 24, 2005: 2:29 PM EDT
By Jessica Seid, CNN/Money staff writer

NEW YORK (CNN/Money) - Netflix shares have skyrocketed lately, but investors should be wary of getting carried away: The company is benefiting from turmoil at its biggest competitor, and may still face a tough pricing war.

When Netflix Inc. (Research) and Wal-Mart Stores Inc. (Research) announced a deal to co-promote DVD sales and rentals, shares of the online DVD company jumped 30 percent.

But the stock was on a tear even before the deal was announced Thursday, up nearly 40 percent in the last two weeks, and up a whopping 80 percent in the last two months, while the Nasdaq Composite has remained relatively flat. It remains unclear what exactly sparked the meteoric rise in Netflix.

Netflix would not comment on market rumors or speculation.

A spokesman from the Securities and Exchange Commission would not comment on whether it was investigating the dramatic rise in Netflix stock, but regulators routinely look closely at any trading activity that precedes market-moving news.

One thing is certain, with the competitive landscape for the online DVD rental industry narrowed to just two players, a string of bad news for Blockbuster has spelled good fortune for Netflix.

I can do anything you can do...cheaper

Netflix and Blockbuster have been locked in a price war since last fall, when Blockbuster launched its online service, but things really started heating up after Blockbuster undercut Netflix's subscription price in October, sending shares of Netflix plummeting 40 percent.

Then in March, Blockbuster announced that it was pulling out of the bidding for Hollywood Entertainment and triggered criticism from billionaire financier Carl Icahn.

Three days later, Netflix announced the number of subscribers to its DVD rental service had surpassed 3 million, continuing the company's course of growing its subscriber base by more than 50 percent annually. Shares rose more than 8 percent on the news.

After Carl Icahn, who has pledged to cut costs at Blockbuster, was elected to its board of directors last week, shares of Netflix jumped another 12 percent on speculation that Blockbuster would shut down its fledgling online rental service, the company's biggest expense.

"Netflix investors were saying, 'Obviously Blockbuster is going to abandon online,'" Wedbush Morgan Securities analyst Michael Pachter said. But, "it's not going to happen."

Blockbuster has been slow to compete with its feisty rival, according to Pachter, but it is well positioned to close the gap relatively easily by amping up its offerings or forming a strategic partnership. Pachter speculated that a Blockbuster-Amazon (Research) alliance could lie ahead.

And although Icahn has indicated little willingness to spend on such new initiatives, Chairman John Antioco reassured staff that the movie rental chain would not abandon its online strategy and the company announced it will invest $170 million in its online-rental operation this year.

Fitch cut Blockbuster's debt ratings deeper into junk after Icahn won a seat on the board, feeling that the move could introduce a spell of uncertainty to the movie renter. Shares of Netflix stock gained 7 percent in response.

On Wednesday, Blockbuster started testing a fee of $18 for unlimited monthly DVD rentals, indicating it may be considering dropping out of the pricing war. Netflix stock rose another 7 percent.

But a day later, the movie renter launched an offer of two free months of DVD rentals to Netflix and customers who switch to its rival online rental service, and said it still aims to have 2 million users by the end of the first quarter of 2006, sending Netflix shares down over 1 percent.

So as the ongoing duel between Netflix and Blockbuster unfolds, investors may need to brace themselves for a bumpy ride.

Now's the time to gut-check your risk level on this stock. Click here.  Top of page


Netflix Incorporated
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