Netflix’s Quarter From Hell

According to the latest comScore report on online video viewing for December 2011, 182 million U.S. Internet users watched online video content. On average, 23.2 hours of content were watched per viewer. A total of 43.5 billion videos were viewed online by U.S. Internet users. The figures translate to an impressive 85% of the U.S. Internet audience viewing online video content. Google sites were ranked as the leading online video content destination with more than 157 million unique visitors in December accessing 21.8 billion videos. Despite its immense popularity, Netflix did not even figure in the top 10 destinations in that month.

Netflix’s Financials
For Q4, Netflix’s (NASDAQ:NFLX) revenues grew 47% over the year to $876 million, ahead of the market’s expectations of $857 million. EPS of $0.73 was also significantly ahead of the Street’s targeted $0.54. The company added 610,000 customers during the quarter, ending with 24.4 million subscribers globally.

International revenues in the quarter grew 33% over the year to $29 million and reported a loss of $60 million. Netflix is now available in Canada, several Latin American countries, and recently in the U.K. and Ireland as well. During the quarter, Netflix added 380,000 new international subscribers compared with previous quarter’s addition of 510,000 added new subscribers. They ended the quarter with 1.86 million overseas subscribers.

For the current quarter, Netflix sees international revenues to bring in $38 million-$43 million with a net loss of $108 million-$118 million and a paid subscriber base of 1.9 million-2.45 million. Overall revenues for the quarter are projected to be $842 million-$877 million with a loss of $0.16-$0.49 per share. The Street was looking for revenues of $846 million with a loss of $0.29 per share.

Netflix’s DVD Business
Netflix has stepped up efforts to move away from the DVD business and saw their DVD subscriber base fall 20% sequentially to 11.17 million. Analysts aren’t entirely convinced this is the right move given that the DVD segment has higher margins. According to their financials, Netflix’s DVD-by-mail service customers earn them 52% margins compared with 11% earned on domestic streaming customers.

However, buoyed by the growing demand of online viewership, Netflix has shifted the emphasis to online streaming. Incremental margins on streaming content are also higher because the service does not involve any cost of shipping, handling, and DVD-buying fees. The costs involved in streaming content are related to content licensing costs, which are paid upfront. Hence, as the number of streaming customers increase, the cost per customer continues to drop, thus making the business more viable.

But retaining online content is becoming a bigger challenge. Netflix was expected to renegotiate terms with Liberty Interactive Corp., the organization that holds content rights for Sony and Walt Disney. They have also lost content right for Starz and, starting next month, will no longer be able to host popular titles such as “Toy Story 3” and “Tangled” as part of their online content library. Netflix isn’t exactly worried, saying that Starz content accounts for only 2% of their online viewed videos.

According to the Digital Entertainment Group, in the first three quarters of 2010, fourteen million DVD players were sold in the U.S.. The report also estimates that there are more than 91 million households in the U.S. that have DVD-playing equipment, and that number does not include computers and game consoles. It does not seem that DVD viewing is truly going out of business, and Netflix may want to reconsider their plans of ending that program for their customers.

Netflix’s Global Expansion
As part of their international expansion plans, Netflix began their streaming service in the U.K. and Ireland earlier this month. Their competitor, Amazon, already has a foothold in the market through their acquisition of LOVEFiLM last year. But, if the initial reports from the market were to be believed, both players stand an equal chance. Amazon’s LOVEFiLM is a pound cheaper than Netflix’s price of £5.99 a month. However, customers are more impressed with Netflix’s easier user interface, better picture quality, and an improved range of compatible consumer electronic devices and mobile device apps. LOVEFiLM, though, has better movie content, while Netflix is said to have a better TV show library.

Netflix’s stock has seen a big swing when it reached an all-time high of $304.79 in July and fell to a low of $62.37 in November 2011, after it announced an unsuccessful attempt to increase prices and split the DVD and streaming business. While the pace of customer acquisition has increased since then, the analysts are still skeptical of their plans. For now, the stock has recovered somewhat and is trading at $115.80 with a market capitalization of $6.9 billion.