Why Netflix investors shouldn't celebrate yet

January 15, 2014: 1:25 PM ET

Its offerings of television shows and movies are mediocre at best, and competitors are catching up.

By Sanjay Sanghoee, contributor

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FORTUNE -- At almost $338 a share, Netflix (NFLX) stock has surged more than fourfold since the start of last year. Next week, the video streaming company is expected to report earnings for the final quarter of 2013, but before investors get too excited, they should take a deeper look at the company.

Netflix's subscriber base and revenues have grown rapidly, but its offerings don't justify the hype surrounding its service, and its licensing philosophy could eventually lead to the company's decline. According to analysts, the rapid rise and current price level of Netflix stock suggests that the market is expecting the company to increase its domestic subscriber base from 30 million to 60 to 65 million in the long term, representing 57% to 62% penetration of broadband households. That's aggressive, not least of all because other streaming services like Amazon (AMZN) and HBO GO, with subscriber counts of 10 million and 28 million respectively, will also be expanding their share of that finite pie at the same time.

Despite the bullish outlook, the stock may be overpriced, and the higher number of subscribers that analysts have projected may never materialize.

For one, Netflix's streaming movie content is mediocre at best. The company keeps adding to its library, but the bulk of new additions are either dated or extremely obscure. It also keeps dropping popular content, such as Titanic and War Games. Netflix does occasionally bring movies back but in a wildly unpredictable way. This would be fine if the company's primary business were DVD rentals (as it once was), but Netflix wants to be the definitive gateway for digital distribution, and so its random menu of content on instant play is all the more bewildering.

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Behind this disconnect is its own licensing muscle. As the company's subscriber base has grown, so has its power and stubbornness in licensing only what it wants and second-guessing the studios. The issue is not necessarily one of price but of duration. Netflix claims that it knows what its users want and therefore will keep certain content indefinitely while it licenses other movies and shows for very short periods. That might make sense in the short term, but this leads to an inconsistent user experience over time (the movie, 48 hours, keeps disappearing/reappearing so fast you would think the title referred to the license).

To be fair, Netflix's real value lies in its TV offerings. The convenience of being able to stream all the episodes of your favorite TV shows instantly without the annoyance of having to wait for multiple DVDs in the mail is extremely valuable, and so too are the original series that Netflix has rolled out recently, including House of Cards and Orange is the New Black.

Even on these fronts the company's performance leaves much to be desired. For syndicated shows, a delay of anywhere from six months to a year after a season ends before new episodes come online is a serious frustration for viewers, especially if spoilers on the Internet give away major plot points in the interim. Secondly, competitors like Amazon are also rolling out original digital content like Alpha House, which could eventually erode Netlfix's advantage in this area as well. The company will have to invest regularly in new shows just to keep its subscribers interested, which will be expensive (the company spent $160 million in 2013 for 3 shows alone).

Also catching up is Hulu, the online TV and movie distributor owned by a consortium of Disney, Fox, and NBCUniversal. With a paid subscriber base of 5 million, it carries TV offerings that are 1) more current (new episodes of five of the top six broadcast shows), 2) priced at the same level as those of Netflix, and 3) more readily available to the service because of its inside relationship with content providers. It also carries original programming, which it plans to ramp up this year.

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There are also issues with the price point. The company has stated that it wants to migrate its subscribers away from DVDs and toward streaming, but that would entail having to increase its streaming fees in order to make up for lost DVD revenues. That could be extremely tough without improving the quality and timeliness of its streaming content. And even if Netflix hopes to make up the revenue shortfall through increased subscriber volume, older subscribers are unlikely to keep paying $7.99 a month for decades-old episodes of Law & Order or a cinematic masterpiece like Spaceballs indefinitely.

Investors should take all this into account, and so should Netflix CEO Reed Hastings, before the bubble bursts, or the movie ends.

Sanjay Sanghoee is a political and business commentator. He has worked at leading investment banks Lazard Freres and Dresdner, as well as at multi-billion dollar hedge fund Ramius. His opinion pieces appear in Christian Science Monitor, Time, Bloomberg Businessweek, FORTUNE, and Huffington Post, and he has appeared on CNBC's Closing Bell, MSNBC's The Cycle, TheStreet.com, and HuffPost Live on business topics. He is also the author of two thriller novels. For more information, please visit http://www.sanghoee.com

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