Media Wonk

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Irrational exuberance over Netflix? - May 20, 2008

Shares of Netflix took off like Diet Coke in a barrel full of Mentos this morning as news broke of a new set-top box from Roku that lets subscribers stream movies from their Netflix Instant viewing queue to their TV set. By mid-morning, shares were up more than 10% and volume was on a pace to match an average day's trading by lunch time. Lehman Brothers analyst Douglas Anmuth upgraded the stock from "equal weight" to "overweight."

Apparently, the market read the news as a sign that Netflix was making the jump to light speed at last and would soon be beaming movies around the Internet instead of mailing out those musty old DVDs in the flimsy red envelopes.

Not so fast. Media Wonk has had an opportunity to play around with one of the new Roku boxes for about a week and can report that it's a nice first step but the journey ahead is still a very long one.

The five-inch by five-inch box is easy to set up. Media Wonk used his wireless home network to connect it to the Internet and plugged it into the TV via composite video because he didn't have an HDMI cable handy. Piece of cake. Picture quality on a 42-inch Toshiba LCD was adequate if not spectacular. Playback was mostly smooth with an occasional hiccup but nothing worse than what Media Wonk sometimes sees with a VOD movie over Comcast.

The problem--as always--is there ain't much to watch with it. Only about one-tenth of Netflix's vast library is available for streaming thanks to the studios' niggardly approach to licensing, and most of what is falls into the strictly-from-hunger category.

That's not Netflix's fault. But it should put the Roku announcement into some kind of perspective. The Roku player solves the technical problem of getting streamed content from the PC to the TV, and it does it in an inexpensive, simple-to-use way. But the real challenge facing Netflix is not technical. It's a lack of rights. And the Roku box does nothing to change it.

More to the point: The biggest issue that should concern Netflix shareholders with respect to digital delivery--as with Blockbuster shareholders, Vudu investors and Apple acolytes--is that Netflix has no control over the most important variable in its digital business model beyond pleading with the studios. No amount of execution, strategic planning or balance-sheet finagling by Netflix will affect the rate of growth of its digital distribution business. The rights will come when they come. And when they do, everyone will get them. There's simply no way of knowing at this point when investors might see a return from Netflix's digital business.

Netflix, in fact, isn't even really trying to monetize what Roku has wrought at this point, at least not directly (unless, perhaps, it's getting a commission on the boxes sold through the Netflix web site). A subscriber with a $9.95 a month Netflix account can buy a Roku player and stream as many movies as they want at no extra charge. At best, it's an anti-churn tool, which might have some marginal impact on subscriber acquisition costs.

All of which amounts to a perfectly reasonable first step for Netflix. But it's a baby step to be sure.



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