Netflix’s Earnings On Deck Monday: Turnaround Continues With Eye On Content Costs

by Trefis Team
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Netflix (NASDAQ:NFLX) will be reporting its Q1 2012 earnings on Monday, April 23. After a roller coaster ride last year and a surprisingly positive start this year, Netflix has become a stock of great interest to the investors who are expecting a turn-around in its subscriber trends. We expect substantial improvement in subscriber gains compared to what Netflix has seen in the past 2 quarters; however, overall costs will be high. It will also be interesting to see Netflix’s progress in international markets in terms of subscriber additions and churn rate. Netflix is facing increasing competition from domestic players such as Amazon (NASDAQ:AMZN), Dish Network (NASDAQ:DISH) and others and international expansion can reduce that risk.

See our complete analysis for Netflix

Expect subscriber trend Improvement, but future under doubt

Although we expect Netflix to lose between 1 to 2 million DVD subscribers in Q1 2012, most of these losses will result from shift of hybrid subscribers to streaming-only plans. Thus, actual subscriber losses will be lower and will be more than compensated by gross additions. In fact the company mentioned during its last earnings that 1st month of 2012 saw subscriber trend resembling that from Q1 2011. It is likely that this significantly improved subscriber trend would have carried on for the whole of Q1 2012. Even though competition developed, the impact will be visible in future.

Recently, a flurry of competitors have sprung up and existing ones have gotten stronger. Amazon started a stand-alone streaming service, Verizon (NYSE:VZ) is going to launch a streaming service in partnership with Redbox and Comcast launched its Xfinity Streampix. Over the course of next few quarters, these competitors will spend significantly on content and customer acquisition and that might pose problems for Netflix.

We look forward to Netflix’s comments regarding how the company will tackle the developing competition and differentiate itself. According to our estimates, U.S. streaming subscription business accounts for about 60% of Netflix’s business.

Costs will be higher

Undoubtedly, the content costs will shoot up as a result of Netflix spending heavily on content. From new competitors to making a name in international markets, acquiring better content is clearly an inevitable task in order to survive. However, content comes at a cost. Netflix already has significant content liabilities and its content spending is going to almost double this year. Moreover, the company has been pushing for original content which costs even more. Content costs (as % of revenues) is a key driver of Netflix’s profits. The key for investors will be to focus on the long-term benefits of this high initial content spend that can help Netflix stay ahead of its competitors and gain subscribers.

International trends are important

Given that competition in the U.S. is on a rise and Netflix is spending heavily on international expansion, investors should look for subscriber gains in Canada, Latin America and the U.K. International expansion can diversify Netflix’s risk. Currently we estimate that this business accounts for 25% of Netflix’s value as we expect the company to gain several million international subscribers over the course of next few years.

Our price estimate for Netflix stands at $131, implying a premium of little over 20% to the market price.

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