The comments by
Netflix Inc.
's (
NFLX
) CEO Reed Hastings at the UBS media conference summarized the
company's current scenario and pointed out where it went wrong.
During the conference, Hastings quoted "
We did so many difficult things this year that we got
overconfident,"
and added,
"Our big obsession for the year was streaming, the idea that
'let's not die with DVDs"
.
However, discounting the threat from online streaming
competitors like
Verizon Communications Inc.
(
VZ
) and
Amazon.com Inc.
(
AMZN
), Netflix recognized HBO Go, a
Time Warner Inc.
(
TWX
) streaming company, as its worthy adversary. Mr. Hastings stressed
on the fact that the future of the company lay in the streaming
business.
HBO Go has a wide variety of content that it can leverage in
gaining traction in the online streaming business. Moreover, like
Netflix, the service is made available for
Apple Inc.
(
AAPL
) devices and also for Andriod-based smartphones.
The developments at Netflix over the past few months can be best
summed up as "How best to ruin a company" or rather, a company that
promised robust growth prospects. Netflix, at its helm, was adding
subscribers every quarter until it resorted to a price hike of 60%
for its services in July 2011. Since then the company has been
reeling under pressure, as it witnessed an exodus of subscribers
(800,000 U.S. subscribers to be exact) in the recently concluded
third quarter.
Moreover, the company had decided to separate the two services
of streaming and DVD by mail and form Qwikster, a new company for
the latter. However, in a complete reversal of their decision,
management scrapped the proposed separation. The turn of events was
reason enough to confuse both analysts and investors. Thus, by the
time management scrapped the idea of splitting the company into
two, the damage had already been done in terms of investor
sentiment and stock prices. Netflix's market value had dropped from
$16 billion to $3.77 billion in a space of just 5 months.
To further sour the mood, management provided a dismal outlook
for the current quarter and fiscal 2012. Though the company
expected to remain profitable on a global basis, it acknowledged
that the exodus of subscribers in the domestic market would
continue in the current quarter, though at a slower rate.
To salvage the situation and get in the good books of its
subscribers, Netflix signed a number of licensing deals with big
Hollywood production houses to provide varied content. But the
deals that are being signed come at a cost. If the company is not
able to recover these costs from its customer base, it would spell
serious headwinds for the company.
The major near-term challenge for the company is cost escalation
in the form of license and renewal fees. Analysts predict that the
company will have to shell out $2 billion in terms of licensing
fees to content providers in 2012, escalating from $180 million in
2010. Netflix said in a regulatory filing that it has
impending payments of more than $3.5 billion over the next few
years that is to be paid for the content under contract. To keep
the company afloat, Netflix has to bank on subscriber growth, both
domestic and international.
Moreover, the company is raising $400 million in cash through
stock offerings at $70 per share and convertible bonds. This seems
to be a desperate move on the company's part to expand its
footprint in the international market, to primarily compensate for
the massive subscriber churn in the domestic market.
We believe that the proceeds from the transaction would also
help Netflix to develop its streaming library, particularly in its
domestic market, which will attract new subscribers going forward.
However, an increasing debt level remains a concern, in our view.
As of September 30, 2011, Netflix had cash and cash equivalents of
$365.8 million, versus a long-term debt of $200.0 million.
Post its planned foray into the U.K. and Ireland in early 2012,
the company has no further plans to expand in the international
market. Expanding into newer regions tend to escalate costs in the
form of technology investments and brand-building initiatives.
However, Netflix cannot completely do away with expansionary
initiatives, which can be used to offset losses in the domestic
market, caused by increasing competition. Also, if Netflix is able
to enter a few nascent markets, it could enjoy a first mover
advantage.
Netflix has already added Latin America and the Caribbean
islands. However, the company has been facing competition from
Telefonica SA's TerraTV and Net Servicos de Comunicacao SA in Latin
America. Further, Latin America's lower income, limited broadband
availability and limited use of credit cards are hurdles for
Netflix's business here. The latter is the biggest concern for
Netflix, as the primary payment mode for subscriptions is credit
cards.
Although Netflix expects to remain profitable on a global basis
for the fourth quarter, we prefer to remain 'Neutral' on the stock
and wait for significant developments.
We currently have a Zacks #3 Rank for Netflix Inc., which
translates into a Hold rating in the short term.
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