By JACK HOUGH
Both companies rose to prominence by beating rivals on price. H-P, the original Silicon Valley garage firm, invented an audio oscillator more than 70 years ago that could be sold for less than half the going rate. Netflix, founded 14 years ago by a Silicon Valley software tycoon, offered DVD fans an all-you-can-watch plan that beat Blockbuster's rental prices, and without late fees.
The Internet now threatens the profitability of both firms. H-P has grown into a diversified maker of personal and enterprise computers and peripherals. But the shift to so-called cloud computing means processing power and data storage are being concentrated into the hands of a few, to be accessed as needed by consumers and workers toting smart phones and tablets. Some old-guard tech firms have been nimble enough to prosper in the cloud (see "Cloud Investing, Buffett- Style"). But H-P is not yet among them.
Netflix should be well-suited to the shift from DVD viewing to video streaming. It has "net" in the name, chief executive Reed Hastings likes to point out. But there's a key difference between DVD rentals and instant video. Content owners who viewed the former as a source of extra cash increasingly view the latter as a threat.
"There is now building evidence that NFLX's streaming presence is now negatively impacting the premium channel subscriber base and rates, both of which will flow negatively back to content owners," wrote Jeff Rath, an analyst with investment bank Canaccord Genuity, in a Monday note to clients. A DVD-by-mail service, after all, is fine for dated movies and old TV episodes, but an instant-on service competes with new programs. That helps explain why Starz Entertainment, which controls cable rights to movies from Disney and Sony, decided not to renew with Netflix next year.
Netflix, then, may ultimately have to settle for a smaller cut of profits in its streaming business than it did with DVDs. It also doesn't help that steaming has attracted heavyweight competitors, including Amazon, Apple and the cable operators.
The economy hasn't helped H-P or Netflix, both of whose customers are looking for ways to cut costs. But both companies have made things worse through management blunders. H-P's former boss resigned after a company investigation found that he used expense reports to hide an affair with a company contractor. The firm has had much more costly flings, of course, from the $25 billion it squandered a decade ago on computer maker Compaq, to the more than $10 billion it agreed to pay this year for Autonomy--a 64% premium over the software maker's market price.
Netflix raised prices in a recession, then split its DVD and streaming businesses and renamed the latter, then undid the split. That angered customers, 800,000 of which left during the third quarter.
H-P has had its stock price cut in half since spring 2010. Netflix, which was priced much higher relative to its earnings to begin with, has lost a stunning three-quarters of its value since this past summer. Which one is the better deal for bargain hunters?
Hewlett-Packard offers more downside protection. New management expects the company to earn at least $4 a share next year. That puts shares at less than seven times earnings. But a turnaround won't be quick: The company faces four to six quarters of investments in cloud services to offset declines elsewhere, according to Jefferies & Company analyst Peter Misek. There is a modest consolation for investors willing to wait: a 1.8% dividend yield.
Netflix, meanwhile, pays no dividend and expects to report losses next year as it invests overseas. If earnings thereafter rebound to their recent pace of $3 to $4 a share per year, and growth prospects look bright, shares could prove worth their current price of close to $70 and perhaps even more. But those are big ifs. Meanwhile, management recently raised capital by issuing shares at $70 apiece. If the company is content to sell at that price, it's unclear why investors should be eager to buy.
H-P seems the safer bet, but investors can surely do better by looking elsewhere in tech. As Black Friday will no doubt remind, not all sharp, sudden discounts are good deals.