Netflix (NFLX) Stumbles on Lowered Revenue Guidance

Shares of movie rental giant Netflix (NFLX: Charts, News) crashed this week despite posting better than expected earnings on Monday. For its first quarter, Netflix posted a loss of 8 cents per share on revenue of $870 million, beating the average analyst forecast for a steeper loss of 27 cents per share on $866 million in sales.

However, investors were spooked by Netflix's weak guidance for its second quarter, in which it estimated revenue between $873 million to $895 million, weaker than the analyst consensus of $897 million.

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This narrow miss caused the stock to crash over 13% on Tuesday. Shares continued to slump throughout the week. Most investors overlooked a bright spot in the Netflix's guidance, in which the company stated that it "might" earn a profit in the second quarter, although its official forecast covered a broad range between a loss of 10 cents per share and a profit of 14 cents per share. The company originally warned that investments in new overseas markets would keep it unprofitable throughout 2012.

Netflix also added 1.7 million new U.S. streaming subscribers during the quarter, bringing its total customers to 23.41 million. Over the course of the year, international streaming subscribers also increased from 1.2 million to 3.1 million. However, U.S. DVD subscribers declined from 11.2 million to 10.1 million. CEO Reed Hastings has claimed that Netflix has the growth momentum to peak between 60 to 90 million global subscribers. Aaron Kessler, an analyst with Raymond Jones & Associates, believes that Netflix will struggle to even reach 40 million.

Only a year ago, Netflix seemed to be an invincible next generation tech stock, destined to take its place alongside Apple (AAPL: Charts, News), Amazon (AMZN: Charts, News) and Google (GOOG: Charts, News). Shares traded as high as $295 per share last July. Since then, Reed Hastings made a poorly advised move to raise prices, which prompted a severe PR backlash across social networks, followed by an even clumsier, aborted attempt to split the company into two halves - for physical and streaming rentals. Investors grew more jaded with Hastings after Amazon aggressively rolled out its streaming service, "Amazon Prime", and Google began offering TV shows and movies through its re-branded "Google Play" store.

While Netflix's earnings are consistent, the company's trailing P/E of 28 demands stronger growth. Rising costs have become Netflix's bottleneck. Content providers are now demanding higher payments for providing their films and TV shows. Over the past year, Netflix lost premium content from Liberty Media's (LMCA: Charts, News) Starz as well as a large portion of its Disney (DIS: Charts, News) library, due to contract expirations. Hastings acknowledged that several other major contracts will also expire in 2014 and 2015, but stated that the company will "spend quite aggressively" to build up its catalog.

Although Hastings pointed out that the hit series "Arrested Development" will return to streaming service early next year, the series has already been streaming on Amazon Prime, with the blessing of News Corp's (NWS: Charts, News) Fox. The same applies to many other shows as well, which are available on other streaming networks. Hastings also noted that the new Kevin Spacey series "House of Cards" will be available starting in 2012, and the company's first original show, "Lilyhammer", starring Steven van Zandt, has been well received.

Netflix shareholders should be wary of growing competition in the market that the company once dominated after the death of Blockbuster. Hulu, which offers in-season shows, is a primary threat, as is Amazon, which has widened its multimedia reach with its popular Kindle Fire tablet, which claimed 14% of the U.S. tablet market in a single quarter. Verizon (VZ: Charts, News) and Coinstar (CSTR: Charts, News) also recently announced a partnership that would offer mobile video rentals on smartphones and tablets.

Each of these competitors are laying siege to Netflix's market in new and creative ways, and the company's moat is not wide enough to hold them at bay. Increasing expenses in international expansion and studio contracts will keep pressure on the company's margins, as its struggles to increase subscribers and revenue at the same time.

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Published on Apr 26, 2012
By Leo Sun
Leo Sun
Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

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