While the 2010 transformed Netflix (NASDAQ:NFLX) from being a mainstream DVD rental provider to online movie streaming leader, 2011 was a mixed bag. Following the exceptional subscriber growth in the first half of the year that propelled the company’s stock to almost $300, terrible management decisions led to a momentous slide and tarnished its image. This has opened up a window of opportunity for newcomers like Amazon (NASDAQ:AMZN) and Dish Network’s (NASDAQ:DISH) Blockbuster.
Our current price estimate of $126 for Netflix implies a premium of about 75% to the market price and is hinged on our expectation that Netflix will recover from this temporary slump. However 2011 showcased the company’s delicate relationship with its customers, which will need to be nurtured even more now.
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Netflix’s Arrogance Turned Out To Be Very Expensive
In beginning of 2011, Netflix seemed unstoppable and the accelerating subscriber additions demonstrated high customer demand for the company’s services. The company misunderstood the reason behind its success and daftly hit customers with a sudden 60% price increase for hybrid subscribers (DVD+Streaming) without explaining the rationale behind this decision. Netflix did not have a content that would make it indispensable, and instead, customers were partly sticking around due to its low subscription price compared to the content it offered.
The decision not only put the brakes on expansion but led to subscriber losses for the first time in many years. The situation was further exacerbated when Netflix announced that it re-branding its DVD business to Qwikster. Netflix reversed this decision later. The subscriber backlash and resulting smaller customer base sent the stock price plummeting. We note that the subscriber losses were primarily concentrated among DVD customers.
Transformation To First-Run Content Owner Began
From being a collator of older content, Netflix began its transformation in 2011 as one of the service providers for first-run TV content. The company acquired series such as House of Cards, Lilyhammer, and is now working with a director on production of 13 episodes of horror series, Hamlock Grove. While this is just a beginning of a transformation, Netflix will face severe competition from traditional pay-TV service providers. This will lead to skyrocketing of content costs as we already forecast.
International Expansion Accelerated
While Netflix began its international expansion in 2010 by entering Canada, the pace accelerated in 2011 driven by increased additions in Cananda and foray into Latin American market. The year further unveiled Netflix’s next international destination, the U.K. and Ireland.
Nevertheless doubts surround the prospect of success of Netflix in Latin America and the U.K. markets. The former poses a hindrance in form of low per-capita income, lack of credit card usage and low broadband penetration. The latter market has strong local competition from broadcasters and Amazon’s Lovefilm. However over a period of 7-8 years, we expect Netflix to gain significant subscriber base in international markets.
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