Netflix's Loss of 800,000 Subscribers Hit Q4 Forecast

Netflix Inc. (NASDAQ: NFLX) reported a loss of 800,000 subscribers as a result of a price hike in July, as well as its disastrous September attempt to split and rebrand its DVD-by-mail service. This has led to a fourth-quarter guidance that was substantially below Wall Street's expectations.

Furthermore, the company said it anticipates an unprofitable few quarters in the near future, starting with the first quarter of fiscal 2012, due to costs related to its launch in the UK and Ireland. The company has explained that this is because domestic profits will not be large enough to cover international investments, global G&A and technology and development.

Despite pricing-related subscriber cancellations, the company reported third quarter earnings of $62.5 million or $1.16 per share, higher than last year's $38 million or $0.70 per share. Revenue grew 49 percent to $821.8 million. Analysts surveyed by Thomson Reuters had expected profit of $0.95 per share on revenue of $811.8 million for the third quarter.

While we dramatically improved our $7.99 unlimited streaming service by embracing new platforms, simplifying our user-interface, and more than doubling domestic spending on streaming content over 2010, we greatly upset many domestic Netflix members with our significant DVD-related pricing changes, and to a lesser degree, with the proposed-and-now-cancelled rebranding of our DVD service. In doing so, we've hurt our hard-earned reputation and stalled our domestic growth, said Reed Hastings, Chief Executive Officer of Netflix.

Netflix currently offers three choices to users - live streaming or DVDs at $7.99 each and both services for $15.98. The company, in July, had separated its unlimited streaming and DVD plans in an attempt to better reflect the costs of each. Later, in September, Netflix attempted to split and rebrand its DVD-by-mail service as Qwikster. However, the branding incident caused a cancellation spree with the price hikes the primary issue.

As a result of the rebranding announcement, Netflix stock slumped about 46 percent. Following this, the company said it would not rename its DVD-by-mail service, stating that its U.S. members would continue to use one Web site, one account and one password to watch films and television shows under the Netflix brand.

In the latest quarter, Netflix lost net 800,000 subscribers in the U.S., compared to 1.80 million net additions last year. The company ended the quarter with 21.45 million streaming subscriptions and 13.93 million DVD subscriptions, which was much lower than the company's forecast of 21.8 million streaming subscriptions and 14.2 million DVD subscriptions.

Looking ahead to the fourth quarter, the company expects to be profitable on a global basis. DVD subscriptions are expected to decline sharply in the fourth quarter. In future quarters, the decline is expected to be modest, as scares over pricing settle down.

Netflix expects fourth-quarter earnings of $0.36 to $0.70 per share and revenue of $841 million to $875 million, while Street predicts a profit of $1.09 per share on revenue of $919.96 million. Net domestic streaming additions are expected to be about flat in November and strongly positive in December.

For the fourth quarter, the company expects domestic streaming subscriptions of 20 million to 21.5 million, domestic DVD subscriptions of 10.3 million to 11.3 million and international subscriptions of 1.6 million to 2.0 million.

Netflix also announced a pause in further international expansion and a halt in stock buybacks to support growth in the business, including a doubling in content spending in 2012.

The company plans to take the streaming contribution up about 100 basis points every quarter and said that 94 percent of members are watching a non-Starz title. In addition, Netflix said duplicated Amazon content that is available on Netflix represents more than half of the total hours viewed for only 2 percent of its subscribers.

Disappointing fourth quarter guidance reflects stalled domestic subscribers growth, heavy investments that will yield losses for much of 2012, and burgeoning content costs 2012/2011, said Youssef Squali, an analyst at Jefferies.

Squali added that while the stock is starting to look attractive, the melting ice cube nature of the DVD business, the early stage of growth for international expansion and growing threats from TV Everywhere, Amazon.com Inc. (NASDAQ: AMZN), DISH Network Corp. (NASDAQ: DISH) and Hulu should keep investors on the sidelines.

We are again lowering our fourth quarter and fiscal 2012 estimates to reflect higher churn (5.5 percent in fourth quarter), slower domestic sub growth offset by faster International expansion, higher content spend and losses from International expansion beginning in the first quarter of 2012, said Squali.

Further, Squali also noted that while hard to handicap, it looks like the amount/frequency of downside revisions may abate given the materially lower estimates that should ensue from this print. As a result, the hold rating on shares of Netflix continues to be in place, while lowering its price target to $90 from $190.

The brokerage lowered its 2011 fourth quarter earnings per share estimate for Netflix to $0.59 from $1.70, its 2011 estimate to $4.12 from $5.10 and its 2012 estimate to $3.95 from $9.69. The brokerage also reduced its 2011 revenue estimate to $3.2 billion from $3.36 billion and its 2012 estimate to $3.92 billion from $4.76 billion.

Netflix stock closed Monday's regular trading up 1.54 percent at $118.84 on the NASDAQ, while in after-hours the stock plunged 27.84 percent to $85.75.