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Netflix Q3 numbers: Recovery or downward spiral?

Netflix (s NFLX) CEO Reed Hastings has his work cut out for him Monday afternoon, as he faces investors for the first time since announcing plans to spin out and re-brand the company’s DVD service — and then quickly backtracking on those plans. Analysts and investors will be watching this earnings report closely, as it will be the first time Netflix has split out revenue and profit lines from its streaming and DVD businesses. The company will also announce subscriber numbers for the first time since changing its pricing and requiring users to pay $7.99 each for its DVD and streaming services — which meant a 60 percent price increase for those who used both.

Here’s what to watch for when Netflix reports its third-quarter earnings numbers later today:

How many subscribers left, and how many stuck around?

When Netflix first announced its price increase, there was some question about what effect it would have on the company’s fast-growing subscriber base. Prior to the announcement, Netflix had seen its subscriber base in the U.S. grow more than 60 percent year-over-year. The company expected some slowdown with the price hike, and estimated in the last earnings report that it would end the third quarter with 25 million subscribers. That was later revised downward to 24 million subscribers, with most of the difference being in the number of DVD-only subscribers who would stick around.

The domestic subscriber number is likely the first thing most people will look at when they examine the health of Netflix’s ongoing business. If subscriber additions were even slower than the company forecast, you can expect the sell-off of Netflix shares — which took the stock from over $300 down to about $115 today. Analysts will also be looking closely at guidance for the fourth quarter, which is typically a strong one for Netflix. Last year, for instance, it added 2.7 million new subscribers in that quarter.

Just how profitable is DVD-by-mail, anyway?

Ever since it first announced its streaming offering three years ago, Netflix has operated with a combined profit and loss numbers for both DVD-by-mail and streaming service. For the first time we’ll see it split those numbers out, giving a view into how profitable each part of the business is.

Since its DVD-by-mail infrastructure has long been built out and paid for, the ongoing costs associated rely mainly on shipping and fulfillment, with some money spent on content (DVD) acquisition. Meanwhile, the costs related to its streaming business are mostly around licensing content and increasing the number of titles available in its library.

When Netflix announced that it would be separating the two — and creating separate business units — it would be able to gracefully manage the death of the DVD business and use the ongoing profits from the declining operations to fund future expansion on the streaming side. Now analysts will have a sense for the health of both and be able to model future financials more appropriately.

With domestic operations lagging, how goes international?

The bulk of discussion will likely center around Netflix’s domestic operations, especially given all the recent issues at home. But Netflix is betting big on its international opportunity, with expansion into Canada and Latin America already underway and plans for the U.K. just announced. With a slowdown in the U.S. expected, it’s more important than ever that Netflix can show it is making headway in other markets.

Netflix launched in Latin America in early September, which means that operations there will have gone on for less than a month before the end of the third quarter. As a result, it’s unlikely Netflix will have any real substantial subscriber metrics to report back from the launch there. However, we’ll be listening closely for any color around how Netflix views the opportunity and initial customer demand in its new markets.

Other topics of interest

Those are the big issues we’ll be paying attention to, but in addition, it’s worth watching out for nuggets of information around some other topics:

  • Social, user identity and authentication. Netflix has partnered with Facebook to enable users to connect their accounts and share what they’re viewing seamlessly through Facebook’s Open Graph initiative. While it’s rolling out the service in international markets, the plan is being held up by a decades-old user privacy law in the U.S. that restricts video services from sharing viewing information. We’re curious if Netflix has an update about its plans or the state of a bill proposed to amend the law.
  • Metrics around viewership. Every now and then, Reed Hastings provides some new info about how viewers are using its service, how much video they’re watching and on what devices. In particular, we’d like to know how many viewing hours the average user tunes in for now vs previous years, and which devices they’re watching on.
  • A big increase in SAC. Over the past few years, Netflix has benefitted greatly from a virtuous cycle of customer approval and good word of mouth. As a result, its subscriber acquisition costs (SAC) have dropped tremendously over recent quarters, as the amount it spent on marketing for each new subscriber declined dramatically. But with customer approval trending downward in the wake of the Qwikster debacle, Netflix will have to try — and spend — that much more to retain customers and bring new ones on board. Just how bad this increase is will go a long way to showing how healthy its domestic business is.

3 Responses to “Netflix Q3 numbers: Recovery or downward spiral?”

  1. While I feel Qwikster was a smarter long term business decision, it was the execution of that decision that went completely haywire.

    1) They should have done it from the beginning, in place of the price increase. The price increase is what primed the negative reaction in the first place. To give a price hike, and then to screw over the users that stuck around through that hike was a little near-sighted. And yes, users were screwed over – usability would change greatly; where you could once manage your DVD queue and instant viewing in the same place (and where an often use case is to queue a DVD when streaming is unavailable) you would now need to log into a separate site, and also hope your title was available in this separate database. Which leads to:

    2) Disregarding the customers’ concerns: trying to phrase the price hike and split as anything other than positive was just a bad idea. Especially in the case of the split, they should have just called it what it was – the need to split a business that is going to grow from one that is going to die out. Pretending things would now be awesome for all parties involved was disingenuous and the public caught onto that instantly.

    3) Qwikster is a terrible, terrible name.

    4) A blog post is *not* the place to announce these things. A letter would have been nice.

    5) Especially considering the reaction from the price hike, they should have really padded the blow that was the Qwikster split – lower price or a month free or *something*.

    6) Pulling back Qwikster was just as bad of a decision, though. Relenting just makes them look even weaker; I suspect the announcement of going into some European markets is a last ditch effort to show confidence right before they release Q3 earnings. Frankly, I think it’s going to be a bloodbath.

  2. Douglas Crets

    I was really sad that they rolled back Qwikster. I am not at all sure why everyone got so upset at them for doing so. I can see how operationally Netflix had to do this, not sure why customers would care so much. I had the feeling that the public was reacting more to media pressure than to any real impact on their lives. It seemed like people with marketing and business degrees started blogging about how awful the move was, and then the public, already apathetic to the change, but woefully misinformed due to their media consumption habits, got in on the game, too. It was almost like Netflix overestimated the power of social media to tell their story, and when it told the story in the wrong way, because the company didn’t control it enough, they lost the battle in what was supposed to be a surefire win.