Why Adding Subscribers Again May Not Mean Netflix Is Fixed
Netflix is likely to reveal a return to subscriber growth when it reports its latest results on Wednesday afternoon, but that might not be enough to mean a full recovery from last year's strategic blunders.
There has been "misplaced confidence" in top-line subscriber growth, according to Wedbush analyst Michael Pachter. "While Netflix may increase subscribers in 2012, it is paying a steep price to do so, triggering overall losses for the year," he wrote in a research note this week.
Netflix and many others believe that streaming is the future and DVDs-by -mail represent the past, part of the reason that Netflix tried to separate its DVD business into a new entity called Qwikster -- a plan it quickly abandoned when subscribers howled. But streaming also provides Netflix gross margins of only 8%, while gross margins on DVDs run 52%. Analysts estimate that Netflix lost 8 million to 9 million DVD subscribers in the second-half 2011.
Streaming is a tougher business partly because Netflix has far less control over how much it spends on streaming content. Its streaming deals typically expire every three years, for example, giving content owners an opportunity to raise prices. DVD deals last longer, while Netflix can control inventory by using its queue system strategically, creating wait times for subscribers to receive the physical DVDs they've requested.
All that means Netflix may report subscriber growth Wednesday without significantly increasing revenue or generating incremental operating profit, Mr. Pachter said.
Netflix would have to sign up four to five streaming subscribers to make up for the loss of one DVD subscriber who canceled because of last year's price hike, according to Janney Capital Markets analyst Tony Wible.
In addition, content costs are expected to continue rising, putting further pressure profits and margins.
Analysts will also be listening for Netflix's early guidance on first-quarter performance -- many expect that the guidance will be disappointing -- as well as color that management gives on streaming's growth potential.
The company faces another stumble next month, when it will lose Starz content, having failed to reach a new agreement with the network. Starz movies accounted for 6% of Netflix's total viewership at the end of the third quarter.
Though Netflix said earlier this month that users streamed 2 billion hours of television shows and movies during the third quarter -- impressive by any measure -- the figure could actually prove damaging for Netflix's relationship with content providers.
"It's telling content providers that they need to charge more for streaming content," Mr. Wible said. "It is also indicating that Netflix could be cannibalizing viewership, with ratings moving over to Netflix at the expense of networks."