Netflix Earnings Beat: Not Enough to Please Investors

Published Tue, Apr 24th, 2012   Justin Fritz, Executive Editor

Netflix (Nasdaq: NFLX) reported decent earnings yesterday. The company lost $0.08 per share, which is a better showing than the loss of $0.27 projected by analysts. Revenue was $870 million – up 21% over the same quarter last year – just barely edging out the predicted $868 million.

And looking forward, the company said that it could finally become profitable again during the second quarter.

However, despite the better-than-expected earnings and Netflix’s optimistic projection, shares are down over 13% today.

Here’s why investors are spooked…

Competition Throws a Wrench in Netflix’s Lofty Goals

Even before the first quarter, Netflix was already facing some new competition to its streaming video crown, from companies like Amazon (Nasdaq: AMZN) and Wal-Mart (NYSE: WMT).

Then, back in February, I wrote about two new competitors that joined the fray…

Verizon (NYSE: VZ) teamed up with Coinstar (Nasdaq: CSTR) to leverage its Redbox DVD kiosk business and develop a Netflix-style DVD-by-mail and streaming video service.

Plus, Comcast (Nasdaq: CMCSA) announced that it was launching a new internet video offering called Streampix. Essentially, it’s a new service – only for Comcast subscribers – that costs $4.99 a month. And customers with more expensive bundles can get it for free.

Granted, after paying well over $100 a month for Comcast’s services, “free” isn’t exactly accurate. But it adds value to the subscription nonetheless, and keeps its customers from taking Netflix for a spin and potentially cutting the cord on Comcast down the road altogether.

Either way, I predicted at the time that the increased competition threatened “to force Netflix’s growth to a screeching halt.”

Currently, Netflix doesn’t seem to think so. The company added 1.7 million new streaming video customers to its U.S. ranks in the first quarter, and it expects a total of seven million new signups by the end of the year.

That’s raising the bar a bit high, though, considering that it expects as few as 200,000 new customers to sign up during the second quarter and, at most, 800,000.

Now, CEO, Reed Hastings, claims that “the business is performing exactly as we had hoped,” and that the problem with slowdown is simply seasonal.

But some analysts don’t see it that way. After all, hitting seven million new subscribers would be equal to the company’s growth in 2010 – when subscribers could get access to both DVDs and streaming content for $7.99. Tack on the fact that the space continues to get more crowded, and hitting 2010’s growth rate seems a bit too optimistic.

As analyst, Aaron Kessler, says, “I don’t think anyone is ready to give Netflix the benefit of the doubt at this point.” And based on the current stock performance, I’d say he’s right.

With that said, here’s what Netflix needs to do to turn things around…

Beef Up Content Acquisition… Or Else

The key to attracting more subscribers is simple: expand the streaming video library.

During its previous earnings call, Netflix said that it was doubling its content expansion efforts over the previous quarter, expecting to add streaming titles throughout the year. And now the company attributes part of its recent 1.7 million U.S. subscribers to these “new content additions.”

The question is, have you noticed a difference?

If anything, I’ve seen a massive decline in streaming options, at least when it comes to movies. Scanning the new release section just wasn’t what it used to be last year – especially the year before that.

True, original and exclusive content like “Lilyhammer” and “Arrested Development” will keep some subscribers on board. But the company needs to up its game big time if it wants to see a meaningful boost to its subscriber count.

However, while Netflix is increasing “content spending sequentially every quarter, [it’s keeping the pace] slower than domestic streaming revenue growth to allow for margin expansion.”

My advice: Perhaps it’s time to dedicate all streaming revenue to new content acquisition. Because if Netflix doesn’t make a major move soon, good luck hitting seven million.

Good investing,

Justin Fritz