Netflix Plummets, Still Not Investment-Worthy
Tom is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
One does not need to take an extremely close look at Netflix’s (NASDAQ: NFLX) Q2 2012 earnings release to see that something is not working out as expected in its current plan to push its streaming services into the international space. Shares were hit by as much as $16/share (almost 20%) in pre-market trading on July 25, and shares today hit fresh 52-week lows. After gaining quite a bit of promising momentum following the firm’s pricing debacle more than a year ago, it appears that Netflix pessimism still reigns supreme.
Second Quarter Results
Netflix’s results were kind of a mixed bag, depending on different metrics at which an investor analyzes. Revenues of $889 million in the quarter – a new record for the corporation – represented a near 13% increase as compared to Q2 2011’s top line of $789 million. Revenues were about on par with analyst expectations.
Netflix was able to eke out a $6 million profit, or $0.11/share, which beat analyst expectations of $0.05/share and represented a nice improvement after the loss taken in the first quarter of 2012. Earnings were, however, down more than 90% year-over-year. Much of the market’s pessimism was fueled by the corporation’s subscriber base growth and management’s expectations about the remainder of 2012.
Subscribers
- Domestic Streaming
The core domestic streaming business continues to chug along in the low single digits. Netflix ended the quarter with 23.94 million domestic streaming customers, which represents a 530,000-customer increase from the first quarter of 2012. The quarter’s growth was much subdued compared to the 1.74 million customers gained in Q1 – nothing to rave about.
- Domestic DVD Rental
Domestic DVD rental memberships continue to slide, as expected, and the total 9.24 million subscribers at the end of Q2 is down by a third from only three quarters ago. At this point there can be no doubt that Netflix management made an irreversible mistake when it announced its large 60% price increase more than a year ago. Although it has gained back the majority of those cancelled memberships through new domestic business (on a total subscriber basis), the corporation is still missing out on attractive revenue growth in its DVD rental business.
If anyone can prove that the DVD is not yet dead, it is close competitor in Redbox (NASDAQ: CSTR). Redbox rented just short of 200 million DVD, Blu-ray, and video game discs in the first quarter of 2012, up close to 20% year-over-year when compared to the same quarter in 2011. Over the past twelve months, the corporation has rented more than 718 million discs at an average rental price of $2.37/disc for a top line intake of more than $1.7 billion. This is by no means chump change, especially considering that Netflix’s most recent quarterly DVD rental intake was $291 million.
Redbox also recently proved the relatively low price inelasticity of its service through its own DVD rental price increase. Coupled with the infusion of higher-priced Blu-ray and video games into its offerings, average rental prices of $2.56/disc were achieved in the corporation’s most recent quarter – implying that the past twelve month performance figure does not give full credit to the firm’s upcoming potential.
- International Streaming
The most important growth platform for Netflix going forward is the expansion of its core streaming service into the international space. Netflix has been incrementally launching itself into new markets, starting with Canada 22 months ago, Latin America 10 months ago, and UK/Ireland six months ago. The corporation now boasts an international streaming subscriber base 3.62 million strong, up almost 3.75x when compared to the figure at the end of Q2 2011. The 555,000 international streaming subscribers added during the quarter, however, represents a considerable slowing in the division’s growth and were well below analyst expectations. Likewise, with another $89 million lost in the division in the quarter, it is certain that it will be quite a while before international streaming operations can fund their own growth.
Can it Grow Fast Enough?
In early July CEO Reed Hastings made a Facebook announcement that Netflix subscribers streamed more than 1 billion hours of online video content in June, a fairly substantial milestone for the service. During the following trading week Netflix shares popped by as much as 25% based on the notion that a huge surge in watched hours implied a equally impressive increase in the firm’s subscriber base. As it turns out – based on Netflix’s most recent subscriber figures – the implications were not fully correct.
It now appears that it is make or break time for Netflix’s business. With the still-profitable DVD rental business hemorrhaging customers and with the domestic streaming operations not growing fast enough to make up for the difference, it is now time for the corporation to really make a huge splash into the international sector. This holds especially true considering that there is a ton of competition knocking on Netflix’s domestic streaming door.
- Comcast’s (NASDAQ: CMCSA) Steampix streaming service may only be available to the corporation’s 22 million cable TV subscribers, but it is likely that it will act as an anti-churning tool. Until now, many of the subscribers that Netflix has gained have been consumers that have cut their cable cords for less expensive entertainment alternatives. By dangling something in front of consumers that will keep them happy, Comcast’s new service might not be a Netflix killer but it does have hopes in slowing down this cable-cutting trend.
- Redbox understands the valuable package it can offer to entertainment-hungry consumers by supplementing its DVD rental services with a digital streaming option. The corporation’s joint venture with Verizon (NYSE: VZ) – aptly named Redbox Instant by Verizon – does not yet have any firm pricing information available just yet but the service will be launched later in 2012. Consumers will probably not be blown away by the service’s movie selection, as Hollywood studios have been reluctant to give Netflix access to recent films and there is little reason to think they will treat Redbox differently. Deals with Viacom’s Epix will give the Redbox/Verizon service access to some recent movies that Netflix streams, however. Similarly, subscribing consumers will also be given a number of rentals from Redbox’s physical DVD kiosks, so the full package does appear to be adequate.
As mentioned, it is unlikely that either of these upcoming alternatives will completely kill off Netflix, but it would also be foolish to believe that they cannot hinder the firm’s domestic growth over the mid-term. This comes at a time when holding firm to domestic operations is crucial – it is funding Netflix’s all-important international expansion efforts.
Where To?
Netflix management expects a shaky second half to 2012. After nearly breaking even in the first half, the company projects profit to be between -$6 million to $8 million (essentially breakeven) for Q3. Likewise, the firm’s next international expansion push in Q4 will leave investors in the red for the quarter, per company management. This leaves a very serious risk that Netflix will take a loss for the full year of 2012, which would be a heart breaker considering the company grew earnings by more than 40% in each of the past two years.
Although the company can sustain a small loss for the period – net cash is ample – things will not look very good if it cannot pump out some impressive international growth and get a self-sustaining international operation up and running. As for using the 20+% price drop as an entry point into a Netflix investment – shares are not only more expensive today than they were prior to the earnings release (trailing P/E 35x versus 27x), but there is bound to be more price-crushing bad news on the corporation’s near-term horizon with the rather unpredictable second half of 2012 coming up.
gibbstom13 has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook and Netflix. Motley Fool newsletter services recommend Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.
