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Summary:

Netflix faced Wall Street analysts Monday to explain why its new subscription plans were a good idea. While many on Wall Street were surprised by the effect it will have on customer additions in the short-term, most agreed that the change won’t affect the long-term story.

Reed Hastings

Wall Street giveth, and Wall Street taketh away: After being one of the highest-flying stocks in recent memory, Netflix is seeing its shares come down to earth a bit after reporting subscriber additions that were slightly below expectations. More importantly, investors are being cautious after Netflix announced that a change to its pricing plans will slow subscriber growth in the third quarter.

A day after Netflix announced its second-quarter earnings, here’s a roundup of reactions from Wall Street analysts covering the stock.

Goldman Sachs expects churn to increase from 4.1 percent in the second quarter to 5.7 percent in the third quarter, driven largely by the price increase to DVD-and-streaming subscribers. But that’s expected to drop back down to usual levels in the fourth quarter. But the higher churn is offset by higher average revenue per user (ARPU), it reports:

“Domestic ARPU declined 7% yoy due to a mix shift towards streaming-only customers at $8/month. While we expect 3Q2011 ARPU to decline 1.5% qoq from 2Q’s $11.49, we believe that ARPU could increase almost 10% qoq to at least $12.33 in 4Q, which will be the first full quarter of the recently announced pricing increase.”

Morgan Stanley believes that Netflix is in the midst of cyclical growing pains, not a long-term deterioration in its growth story. It also still thinks Netflix has the best price-to-value proposition around. That said, the firm recognizes that the “bull case” buoying the Netflix stock isn’t playing out as well as some have expected in some key growth areas:

Social media integration, which served as a share price catalyst in recent months, is not yet allowed in Netflix’s largest market. Canada continues to trend toward the mid-point of management’s expectations, a negative in our view given that some investors were using Canada as a primary driver for ‘country by country’ penetration models. We continue to appreciate the company’s long-term competitive position and would become more constructive on a risk-reward basis if weakness persists.

While the price hike will have a larger effect on subscriber additions than Wall Street might have expected, J.P. Morgan agrees that it doesn’t change Netflix’s long-term story or value proposition. Furthermore, it sees some benefit to Netflix separating its streaming and DVD business operations:

“[A]fter 3 quarters of strong streaming only growth it became clear that this business could stand alone and that incremental profit from higher DVD pricing could be used to increase the quality and volume of streaming content overall. At the same time, the DVD business may now be better managed for longterm performance and profitability. While DVDs overall are becoming less of a differentiator for Netflix’s service, the company still expects 60% of 3Q11 ending domestic subscribers to use DVDs.”

Despite Netflix’s growing pains domestically, UBS Investment Research notes that there’s opportunity for growth internationally. While Netflix’s success in Canada gives it some confidence with an ambitious launch in 43 Latin America countries, it could face some challenges in the region:

Adoption into the region is expected to be slower on a per-capita and per-broadband basis, due to lower penetration of video game consoles and payment methods. In Latin America, Netflix will likely not benefit from the brand ‘halo effect’ as it did in Canada.

Among other things, Citi notes that DVD shipments have likely peaked. But for Netflix, that’s actually a good thing. Fewer DVD shipments lowers costs in that business, which translates to improved fundamentals and more money that can be spent on streaming content acquisition.

We estimate NFLX spent about $500MM to $600MM in postage costs in 2010. At about $0.88 per DVD shipment, this translates to about 625MM shipments per year. Thus, for every 1MM reduction in DVD shipments, Netflix could save $880K in postage costs. In addition, variable costs associated with fulfillment center staff could also become a source of savings (or funds) for Netflix.

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  1. With Redbox stocks dropping and blockbuster busting, what does this Netflix flounder mean for the movie rental industry? It seems as though they are trying to emphasize video streaming, but the options are too limited, I think, for people to be satisfied with just streaming service. Will Netflix simultaneously strive to increase their streaming offerings? If so, they had better market that pretty aggressively!

  2. Physician Recruiters Tuesday, July 26, 2011

    Very interesting info. I myself am a Netflix subscriber and recently received an email about the increased prices if you wanted to get DVD’s. It does make good business sense to charge a bit more especially after seeing the numbers you came up with!

  3. All these big wallstreet analyst are the same people who are helping to build one of the greatest bubble stocks in American history. What Netflix has become is a shady company just like Enron with the results being the same once the book is written. I am appalled that the SEC has not stepped in yet also the 25 million subscribers have never been independently verified. There are only 25 million subscribers because Netflix says there are no proof!!!

  4. All of this money information sidesteps the one fact that is going to cause Netflix to die if they don’t wise up: They can’t seem to go more than a day without a #$%^&* streaming outage. I don’t even trust them any more. We can be right in the middle of a great movie or TV program, and CRASH. If they don’t get their hardware and software fixed, then who cares? I’ll go to another streaming source – like Amazon.

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