Netflix cuts subscriber targets: Customer rebellion or just a blip?

Summary:Netflix changes its pricing and comes up 1 million subscribers short of what it expected.

Netflix cut its subscriber outlook for the third quarter and said it would come up 1 million short of its initial targets as uncertainty over its pricing changes hurt customer acquisition.

On July 25, Netflix said that it expected to have 37 million subscribers---streaming and DVD---in the third quarter. Now it expects 36 million.

Netflix said that its financial outlook hasn't changed. In other words, the financials add up for Netflix. Wall Street is expecting Netflix to report earnings of $1 a share on revenue of $819.3 million.

The issue is obvious: Netflix split its services into streaming and DVD offerings. To get 1 DVD and streaming it's $15.98 and a hefty price increase. Netflix has expected churn to increase and it's worth noting that its financial outlook hasn't changed.

For Netflix the big question is whether this subscriber dip is just a blip or start of something more worrisome. Netflix stuck to its guns on the pricing change and said that the move was strategically sound. The company said:

Despite the guidance revision, we remain convinced that the splitting of our services was the right long-term strategic choice...We know our decision to split our services has upset many of our subscribers, which we don’t take lightly, but we believe this split will help us make our services better for subscribers and shareholders for years to come.

Uncertainty abounds

Netflix's warning about its subscriber totals comes at a bad time. Just a few weeks ago, Netflix and Starz, which accounts for multiple titles in the streaming library, have broken off talks.

The end of the Starz negotiations means that Netflix may be staring at a content hole in its streaming service in 2012. In other words, Netflix may have to spend more on content and still lose subscribers to other streaming services and DVD rental kiosks from the likes of Redbox.

Given the uncertainty, investors in Netflix weren't sticking around.

Analysts were mixed on Netflix's new subscriber outlook. Morgan Stanley analyst Scott Devitt noted that the reality of the price increases bites. Devitt said:

Netflix blazed the streaming trail and its success now positions the company with 1) difficult U.S. comps, 2) more competition and 3) an investment cycle. We believe the price increase had the negative short-term effect of reducing one of the best consumer value propositions on the Internet while giving Netflix a stronger long-term capital base from which to grow (international development and more U.S. content). We think there may be an investment case for Netflix shares that builds in the next year or so based on a thesis that Netflix business model / access to capital positions it well to acquire premium TV content directly from studios … but this content does not seem accessible until 2014/2015 at the earliest.

Devitt added that Amazon's tablet launch will also be a threat to Netflix.

Stifel Nicolaus analyst George Askew downplayed the concerns.

There is no crisis at Netflix in our view. Fewer 3Q11 domestic subscribers than guidance is a disappointing development. We believe we are seeing temporary churn related to the pricing change, but not a long-term crack in the business model. The company’s facts show the company’s subscriber mix is shifting even more rapidly to the streaming service. This trend should be positive for the company’s franchise and margins as spending on postage and fulfillment can more quickly be shifted to streaming content purchases. The real message here is that the DVD is even more dead than we thought; short the post office, but support your local postal worker.

Related:

Netflix, Starz to break up: One crazy ride ahead to Feb. 28

Topics: Hardware, Banking, Mobility

About

Larry Dignan is Editor in Chief of ZDNet and SmartPlanet as well as Editorial Director of ZDNet's sister site TechRepublic. He was most recently Executive Editor of News and Blogs at ZDNet. Prior to that he was executive news editor at eWeek and news editor at Baseline. He also served as the East Coast news editor and finance editor at CN... Full Bio

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