Netflix Quick to Dump Qwikster

 Netflix (NFLX) announced Monday that it had changed its mind about formally splitting the company into separate businesses for DVDs (Qwikster) and streaming (Netflix) with distinct websites and billing systems. We labeled this as a panic move at the time, and that description appears to have been accurate. Our $150 per share fair value remains the same. We think the shares are slightly undervalued after the recent huge price decline, but we'd require a large margin of safety before recommending the stock. We think some of these short-term headline-grabbing issues take the spotlight away from the fact that Netflix lacks an economic moat and faces several long-term challenges.

John Wooden, the legendary basketball coach at UCLA, had a famous saying, "Be quick, but don't hurry." In a brief press release, CEO Reed Hastings touched on the same theme, saying, "There is a difference between moving quickly, which Netflix has done well for years, and moving too fast, which is what we did in this case."

We've never really understood the company's decision to demarcate the DVD and streaming businesses in the first place. There is room to invest in the streaming business and use DVDs to keep customers satisfied at the same time. We think the July price increase was necessary to help Netflix invest more in streaming, but it was a mistake to not offer a discounted price to customers taking both DVDs and streaming. The company had a competitive advantage in the DVD rental business, but as we've stated repeatedly, streaming is a whole different ballgame as deep-pocked competitors like  Amazon (AMZN),  Apple (AAPL) and  Google (GOOG) are viable threats. We think the company's best strategy would be to use the combined streaming and DVD offering as a comprehensive plan. While the streaming content is limited, customers could use the deep library from the DVD service to fill the void. While waiting for a DVD in the mail, customers could satisfy instantaneous demand with online viewing.

Aside from the recent moves that upset its customers more than it expected, the recent Starz announcement about ending negotiations for streaming  Disney (DIS) and  Sony (SNE) movies demonstrates the negotiating power of content firms and that movie content will get much more expensive. Netflix chose to spin the news as a decision to remain disciplined about content costs, which flies in the face of the high prices the firm has paid for old TV content within the last year. We also think Netflix will struggle to acquire fresh and high-quality content as the current pay-TV ecosystem has a lock on this programming.

Competition is looming from pay-TV distributors and cash-rich technology firms. If Netflix's lofty subscriber growth is predicated on streaming content still being in the "early innings," then the competitive landscape should be viewed in the same manner. We split the competition into two buckets: (1) the existing pay-TV distributors and (2) cash-rich tech companies. For example, Apple's cash balance is more than 20 times Netflix's projected 2011 sales. Although Netflix may have some first-mover advantages with its streaming platform, there are few switching costs and we believe pay-TV distributors and cash-rich technology companies are in a better position to license quality content over a longer horizon.

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