Netflix Shares Fall
Ad Costs Spook Investors
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Netflix Shares Fall, Ad Costs Spook Investors
Tue February 24, 2004 07:03 PM ET
By Bob Tourtellotte
LOS ANGELES (Reuters) - Shares of online DVD renter Netflix touched their lowest level in more than six weeks on Tuesday, one day after the company said it would post a wider first-quarter loss on higher marketing costs caused by rapid subscriber growth.
Late Monday Los Gatos, California-based Netflix, which rents DVDs for a monthly subscription fee of $20, said more television advertising in test areas was boosting subscribers to a higher number than it had initially expected.
But the news of higher costs associated with that growth sparked investor worries that competition was increasing and that Netflix would spend more money to obtain each new subscriber.
In fact, Netflix's per-subscriber marketing costs for the first quarter would fall within the range of previous expectations, and overall marketing costs were not expected to increase, Chief Financial Officer Barry McCarthy told Reuters.
Financial analysts said there was no sign that competition was pinching growth at the company.
Shareholders, who have seen the stock rise from a price around $3 in October 2002 to above $30, took profits. Netflix shares closed down 11 percent at $31.20 on the NASDAQ.
"Netflix provided a very 'bullish' update to (first-quarter) guidance that, unfortunately, we believe will likely confuse some investors," Pacific Growth Equities Derek Brown wrote in a research report.
The outlook for higher costs, however, caused Netflix to widen its forecast for a first-quarter net loss, on the basis of generally accepted accounting principles; to a range of $5.6 million to $8.1 million range from a previous $1.2 million to $3.7 million.
Cash flow measures remain positive, McCarthy said.
Long-time Internet analyst, Nolan Quan, see Netflix’s future prospects much differently. “There is a new software product coming to the Internet marketplace that will certainly take away much of the customer base from Netflix. This software application will allow consumers to search a vast data base for video and other files and then select movies, music and games files to be downloaded to that consumer’s hard drive using an online P-2-P distribution system. All content will be licensed and DRM (digital rights management) encoded. This distribution system will reduce bandwidth cost of downloads by up to 97%. The files will be viewable by PC’s and future Home Entertainment Centers much like DVD players are used today.” To date, Quan says that over 26,000,000 free players have been delivered to consumers.” Content licensors such as CinemaNow, StreamWave and AudioLunchBox have already signed support deals. Five of the major studios are in discussions to sell their libraries online in either a PPV, subscription and simple free promotion basis. Quan goes on to say that by the end of 2003 there were some 67.9% of homes with Internet connections versus 65.8% of homes with cable. “Internet access is the ‘must have’ item in today’s home, just as cable was the ‘must have’ item of the 1990’s,” Quan states, that P2P Content Providers' players and other applications like it will likely replace Netflix in the near future as the cost effective faster delivery system that consumers will prefer.”
HIGHER COSTS EXPLAINED
What is happening, McCarthy said, is that Netflix has only recently begun testing TV ads as a way to market its business, and the tests have been so successful, it will be ramping up.
Because Netflix accounts for marketing expenses at the time subscribers sign up, the greater-than-expected growth rate led to higher costs, McCarthy said.
"We would characterize this as a 'get them while it's cheap' strategy, which creates further distance between Netflix and its already distant competitors," Piper Jaffray analyst Safa Rashtchy said in a report.
While several other online DVD renters compete, the future threats are expected to come from mass-market retailers Wal-Mart Stores Inc. and Blockbuster Inc.
McCarthy said it was too soon to know exactly how TV costs would affect the remainder of 2004's expected earnings.
He said the three key measures Netflix uses to guide investors were subscriber acquisition costs, or SAC, which is the marketing cost for each new client, "churn," or subscriber cancellations versus additions, and gross margin, a measure of expenses relative to revenues.
SAC, he said, is seen as staying around $35, meaning the per capita marketing cost is about the same even as the subscriber base grows. Churn is expected to dip in the first quarter and gross margins are seen rising slightly.
Each subscriber has a lifetime value of $70, and it takes about four months to recoup the investment to acquire him or her. So, even though Netflix will spend more, it expects to begin generating higher profits in coming quarters, McCarthy said.
Rashtchy lowered his earnings guidance to 26 cents a share from 30 cents for 2004, but raised his 2003 figure to 85 cents from 82 cents.
Reuters/VNU