Netflix Has A Bumpy, Crowded Road Ahead

By Adam Brownlee | August 01, 2012 AAA

In the second quarter earnings report released on July 25, Netflix dropped 25% to $60.28, on news that domestic subscriber growth is slowing and fears that the company is expanding too fast overseas.

The company added 530,000 domestic subscribers in the second quarter, beating the median projection of 500,000, but many analysts expected subscriber growth to land at the top of the forecasted 200,000 to 800,000 range. After all, June saw a record-breaking "1 billion-plus hours" of streaming video, according to CEO Reed Hastings. Now, in order to reach the 2012 goal of 7 million new domestic subscribers, the company must hit the high end of its third quarter guidance. Some analysts lowered their ratings on the stock.

SEE: 5 Must-Have Metrics For Value Investors

Hands Across the Water
The company additionally reported that it is "likely to sustain another loss at the end of the year" as it pays for an expansion into a fourth, unnamed market outside the United States. Netflix has approximately 3.6 million subscribers in Canada, Latin America and the United Kingdom, combined, operation locations that lost $89 million for the company in the second quarter. Expansion costs in the U.K. helped effectuate a $4.6 million first quarter loss.

Summing up the Quarter
Netflix earned $6.2 million in its second quarter compared to $68 million a year ago. Although earnings exceeded analyst expectations, it was still a 91% drop compared to last year. Revenue matched analyst expectations at $889 million, a 13% increase over last year.

SEE: Understanding The Income Statement

The Playing Field
In the realm of streaming video, Netflix faces stiff competition from the likes of Amazon, Hulu, YouTube, Apple and cable providers. Amazon recently updated its cloud player in attempt to place its digital movie and music content on as many of its devices as possible, and it released an iPad app that allows users to stream and download content on the popular tablet. Hulu recently signed a deal to offer Hulu Plus on the Apple TV.

The Qwikster Debacle
In September of 2011, Netflix suffered from the "Qwikster Debacle" in which CEO Reed Hastings attempted to break off the company's physical, mailed portion of the business from the streaming side of the business. He quickly scrapped the plan after an immense backlash, and coupled with a 60% price hike for the DVD and streaming plan, the failed experiment resulted in a loss of 800,000 subscribers. The stock price plummeted to a low of $64 in November 2011 but rebounded by over 50%, reaching a high of $129 in February.

SEE: Earning Forecasts: A Primer

The Netflix Back Catalog
According to the NPD Group, nearly one-in-three paid movie rentals come from paid, video-on-demand, streaming service services and Netflix is the dominant provider in this segment with a 55% share, down from its peak of 59% in the second and third quarters of the same year.

The company is the world's leading Internet subscription service for DVD rental and video streaming service, delivering digital content to PCs, Internet-connected TVs and consumer electronic devices to more than 30 million subscribers globally.

The Bottom Line
Netflix faces a bumpy yellow brick road ahead and it may not lead to Emerald City. The company is fighting to maintain subscriber growth amid stiff competition from the likes of Hulu, Apple and Amazon, while attempting to expand its non-domestic reach at a high cost. Analysts and stock holders alike are unforgiving when it comes to the subscriber growth number, as evidenced by the plummet on July 25, and it will now be necessary for the company to reach high in order to hit the yearly target. The future of the streaming video market is up in the air, and a crowded field of players are all shoving and reaching to grab it.

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