Netflix tests investors’ risk appetite as signups fall short

July 23, 2013 05:16 AM

Netflix Inc. (NASDAQ:NFLX) posted second-quarter subscriber gains that missed forecasts, rattling investors who bid the stock up almost threefold this year on expectations original shows would fuel faster growth.

The biggest subscription-video service reported 630,000 new U.S. streaming customers in the second quarter, according to a statement yesterday. While above year-earlier gains, that was about 100,000 shy of analysts’ estimates and the company’s highest forecast. The stock, this year’s top performer in the Standard & Poor’s 500 Index, slid as much as 4.8% in New York trading.

Chief Executive Officer Reed Hastings offered a frank assessment of the risk to investors as Netflix, based in Los Gatos, California, races to become the leading global provider of Internet TV. A price-earnings ratio of more than 245, among the highest in the S&P 500, leaves little room for error as Hastings channels resources into non-U.S. markets.

“We are choosing a strategy which has us put essentially all of our domestic profit into international expansion,” Hastings said on a first-ever video investor call. “It definitely takes a strong stomach on the part of investors.”

Netflix fell 1% to $259.37 at 9:37 a.m. and earlier traded as low as $249.50, for the biggest intraday drop since June 20. Through yesterday’s close the stock is up 183% this year.

Original shows such as “Arrested Development” and the Emmy-nominated “House of Cards” are a crucial component of the company’s efforts to attract viewers before must-have studio content becomes available, said Michael Olson, an analyst at Piper Jaffray Cos. in Minneapolis.

‘Fine Line’

The company is spending about 5% of its $2 billion annual content budget on original shows, bolstering its library of films and TV reruns before obtaining exclusive theatrical content from Walt Disney Co. and DreamWorks Animation SKG Inc.

“They’re trying to walk a fine line with originals,” Olson said. “It’s important for buzz around the service but not the main driver apparently for their growth numbers.”

Later this month, Netflix will premiere “Mako Mermaids,” a teen series. The company plans to expand its originals strategy into documentaries and stand-up comedy, Hastings said in an interview.

For the rest of 2013, the company plans the new Ricky Gervais series “Derek,” season two of “Lilyhammer” and “Turbo: F.A.S.T.” from DreamWorks Animation SKG Inc.

Fireside Chat

With yesterday’s results, Netflix abandoned the traditional earnings conference call, where analysts and investors ask questions of management.

Instead, the company held a video interview on Google Inc.’s YouTube, which Hastings said was modeled on fireside chats. Rich Greenfield, an analyst with BTIG LLC, and Julia Boorstin, a CNBC reporter, taking questions from investors, grilled Netflix executives on why they don’t report viewership numbers for original shows or subscriber cancellations.

The executives, including Hastings, Chief Financial Officer David Wells and Ted Sarandos, chief content officer, said they had no plans to change the reporting policies.

“We’re continuing to expand originals because they’re working for us, they’re working for our members,” Hastings said. He also suggested Netflix would own content in the future, similar to Time Warner Inc.’s HBO.

The company will begin offering individual profiles for family members this quarter, according to the statement.

Net Income

Second-quarter net income rose almost fivefold to $29.5 million, or 49 cents share, from $6.16 million, or 11 cents, a year earlier. Analysts had forecast 40 cents, the average of 25 estimates.

Sales increased 20% to $1.07 billion, matching estimates, from $889.2 million a year ago. Netflix charges $7.99 a month for its Web service.

Net income this quarter will be $18 million to $34 million, or 30 cents to 56 cents a share, the company said. Analysts predict profit of 43 cents on revenue of $1.1 billion.

Netflix forecasts 690,000 to 1.49 million new domestic streaming customers in the current third quarter, according to the statement. Analysts, on average, project 1.1 million. The company expects sales of $693 million to $701 million and profit of $161 million to $171 million for the domestic Web business.

For its international streaming business, Netflix forecasts revenue of $170 million to $184 million, and a loss of $70 million to $86 million, according to the statement.

Netflix added 610,000 international subscribers during the second quarter to bring the total to 7.75 million. DVD customers shrank by 470,000 to 7.51 million.

The disappointing number of U.S. signups casts doubt on Hastings’s so-called “virtuous cycle” in which subscriber additions fund ever-increasing program spending, in turn attracting even more users, said Paul Sweeney, Bloomberg Industries’ media analyst.

“If sub growth slows or worse, this virtuous cycle can become more of a vicious cycle,” Sweeney said.

About the Author