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Expensive Mistakes And Rising Costs Plague Netflix

Posted on Tuesday, Nov 1st 2011

In the past quarter, Netflix has managed to not only disappoint its investors but also its customers. Contrary to other online players such as Hulu, which has added customers at a rapid pace during the quarter, Netflix’s loss of subscribers is a shock. The stock price has fallen 75% since the all-time high it attained this summer.

Netflix’s Financials
For Q3, Netflix (NASDAQ:NFLX) saw revenues grow 49% over the year to $822 million with EPS of $1.16. The market was expecting revenues of $812 million with EPS of $0.94. During the quarter, the company lost 800,000 subscribers in the U.S., compared with their projected loss of 600,000 customers. They ended the quarter with a U.S. subscriber base of 23.8 million. The total subscriber base, including those in Canada and Latin America, fell to 25.3 million from 25.6 million a quarter ago.

What’s more, the company’s content cost obligations continue to rise. Netflix now has $3.5 billion in content obligations, compared with $2.4 billion reported in the previous quarter and $1.6 billion reported at the end of the first quarter this year.

For the current quarter, Netflix expects EPS of $0.36-$0.70 on revenues of $841 million-$875 million. The Street was looking for EPS of $1.10 on revenues of $919 million. Disappointment extended into the next year with Netflix projecting a loss for the first quarter as their content acquisition costs rise and they expand into Europe.

Netflix’s DVD and Streaming Separation
Netflix’s subscribers were upset not only by the 60% price rise, but also by the company’s decision to split the DVD and streaming offerings. Netflix justified the price rise on account of rising content and expansion costs. They also accelerated their plans to sever the DVD and streaming business on account of their consumer data that suggested that fewer new customers were opting for DVD shipments.

However, analysts believe that while consumers may not have been ordering as many DVDs as earlier, the “perception of value” was important, and Netflix’s decision to sever the two businesses was not in line with the market demands. The resultant uproar was so strong that Netflix reversed the decision to split the business within three weeks of its announcement, and the combined DVD and Streaming option is back at at the increased price of $16 a month.

Netflix’s Global Expansion
Netflix also faces increasing costs as they expand into international markets. Recently, they added their offerings to the U.K. and Irish markets. But international growth is coming at a high cost.

During the quarter, Netflix added more than a million subscribers in Canada. However, despite the addition, the losses in the international markets doubled to $46 million for the quarter. The current quarter’s losses are expected to grow to $60 million-$70 million.

Netflix plans to stop adding newer international markets during the rest of the year as they shift focus to earning profits in these markets by adding to the streaming subscriber base. Researchers expect Netflix to be able to offer better content in the U.K. as the market is currently not able to offer the streaming choice customers want. However, licensing will remain a big issue as Sky currently holds exclusive rights to six Hollywood producers in the market. Primary hearings have ruled Sky’s practice anticompetitive. It is expected that Sky’s breakup with the Hollywood biggies will come by 2014. Till then, Netflix may have to count on their TV show offerings to lure the market.

Netflix’s stock is trading at $80.28 with a market capitalization of $4.4 billion. It has fallen significantly since its all-time high of $304.79 reached in July of this year.

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