Even Netflix Sings the Blues

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So much for the theory that Netflix (Nasdaq: NFLX  ) is built to weather the economic maelstrom.

The DVD-rental giant lowered its subscriber and revenue targets this morning. It's feeling the pinch as even consumers who decide to stay home fail to pounce on the company's value proposition of movies delivered by mail or streamed digitally.

Netflix closed out the third quarter with 8.672 million subscribers, just shy of its original target of 8.675 million and 8.875 million members.

Burn after reading
Netflix is still growing, thankfully. A tally of 8.672 million accounts is still 23% more than the company boasted a year ago. Despite the slowdown, particularly during the month of August, Netflix is on track to hit its original revenue and profit targets for the third quarter.

Unfortunately, the current quarter is a different story. Netflix is talking down its subscriber and revenue growth expectations, while keeping its net income guidance intact.

Netflix now projects that it will close out the year with 8.95 million to 9.25 million flick-loving subscribers. Its more ambitious earlier outlook called for the company to end 2008 with as many as 9.7 million members.

Where have all the people gone?

Ghost town
Netflix is a survivor. It outlasted the threat of's (Nasdaq: AMZN  ) foray into the DVD rental market. It got Blockbuster (NYSE: BBI  ) to blink first in its mail-based pricing war.

Its push for Web streaming -- a move that now finds Netflix subscribers with access to thousands of on-demand titles through their computers, branded set-top boxes, LG electronics, and eventually Microsoft's (Nasdaq: MSFT  ) Xbox 360 consoles -- is also paying off. You don't hear a lot from the premium digital video-downloading sites like Amazon, do you?

So what's going on here? If the whole "staycation" movement has any merit, one would expect Netflix to be the cornerstone of the home theater. Couch potatoes would rejoice over the availability of unlimited DVD rentals for as little as $8.99 a month (under the "1-at-a-time" plan). That's a fraction of their cable bills or gym memberships, and even less than the satellite radio fees they may be paying to Sirius XM Radio (Nasdaq: SIRI  ) , especially now that they're not driving around so much.

And have you been to a multiplex lately? $8.99 is less than most cinemas are charging for a single prime-time ticket these days.

How to lose friends and alienate people
Most investors may not be worried by these minor guidance markdowns. The company is reaffirming its profitability projections for the third and fourth quarters.

But I'm not so optimistic, even though I'm a Netflix shareholder. Companies like Netflix, Sirius XM, and TiVo (Nasdaq: TIVO  ) spend plenty to acquire new subscribers. Decelerating growth has had a favorable near-term impact on these companies' bottom lines: Losses have narrowed in satellite radio, while TiVo has posted back-to-back profitable quarters. That may look like welcome improvement on the income statement, but I would rather see subscriber-based companies scaling quickly.

Of course, that assumes the company is lowering its subscriber targets because it's having more trouble recruiting new members. If the net subscriber tally is shrinking because of greater-than-expected member cancellations, Netflix has even bigger problems to tackle.

The move toward digital streaming isn't cheap. Since the company isn't charging its customers extra for the service, it shouldered those chunky bandwidth costs and studio royalties to help retain subscribers. Digital cable giants like Comcast (Nasdaq: CMCSA  ) may give away some of their pay-per-view offerings, but their model -- like Amazon and iTunes -- revolves around premium offerings.

Netflix's smorgasbord model makes it a standout. It's a great value, but where are the people?

Sure, missing the low-end of its third-quarter headcount by 30,000 doesn't seem like much of a problem. It's less than half of a football stadium. However, the company's new midpoint for the fourth quarter of 9.1 million members is a whopping 300,000 members short of its previous midpoint. 

If Netflix has a reinvention trick up its sleeve, it better use it soon.

We recommend popcorn with these Fool classics:

The big question: Should Netflix add video game rentals to its service to make it stickier? Post your thoughts in the comment box below. 

Microsoft is a Motley Fool Inside Value recommendation. Netflix and are Motley Fool Stock Advisor recommendations. Try any of our Foolish newsletters today free for 30 days.

Longtime Fool contributor Rick Munarriz has been a Netflix shareholder -- and subscriber -- since 2002. He also owns shares in TiVo. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (3)

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  • Report this Comment On October 07, 2008, at 11:00 AM, techhelp2000 wrote:

    The issue that concerns me about Netflix (I am a customer but I do not own their stock) is their continued use of throttling. That is a term used to describe the way they delay shipment of dvd's for unlimited renters. I fell in love with Netflix during my free 30 day trial period. On day 31, they notified me that an obscure dvd in my queue would be delayed by a week and that I would be unable to cancel or choose an alternate title. Delays were the rule--not the exception--for the next 2 months. I am ready to cancel my membership. This despicable practice will only increase churn and reduce their bottom line. Google throttling+Netflix and you will see many other stories of this nature not to mention a recent class action that they settled. It is time for Reed Hastings to publicly announce the end to this practice.

  • Report this Comment On October 07, 2008, at 11:27 AM, nostradamuslives wrote:

    Well as always the news doesn't show the whole picture and always gives a little optimism to its favorite companies. If you completely understand the model that “movies by mail” or download is built on plus the fickleness of the masses, and what has to give when money gets tight then you'd understand more about the subscriber downturn.

    And who cares how much a theater costs. That is a whole different ballgame. Many people prefer watching the movies in all its glory on the huge screen. And when was the last time they release a movie like “IronMan” straight through Netflix? Never going to happen.

    Hastings has a grasp on good times, but has no clue on tough times. How can he know when it’s been nothing but and easy ride up the hill. How do I know, been in the business. Worked with Blockbuster and ran the third largest DVD rental service.

    What about the fact the DirectTV now has a model to deliver thousands of movies over the internet onto its records at the touch of a button? No mention in your article. Sure, they still charge per movie, but rumor has it they'll soon be offering an unlimited option to take on Netflix and the rest. Thing of all the subscribers that have both Netflix and DirectTV! And many of them will defect to DirectTV. Now would you rather watch movies on your large 65 inch HiDef TV or sit at you're desk staring at your 17 inch monitor, where only one person (not the whole family) can enjoy the movie. And DirectTV downloads (and can be done ahead of time) and saves the movie on your HDR so other in the family can watch it when they have the time, with out delays due to internet congestion.

    And let’s not forget UnBox from Amazon using TiVO service. Nice try. But it’s a “been there done that”, option. And Netflix using Xbox? I have an Xbox so the kids are off playing so I can watch what I want. What does Microsoft and Netflix want me to do? Buy a second Xbox 360? Not a chance.

    On the cost of a customer, that will continue to increase. There is so much more competition than the non competitive days of early Netflix. And they are always the biggest spender. What for a huge adjustment to 2009 projections. They most likely even miss that mark.

    In 2001 a study was done to determine when the Netflix model of movies by mail would start to move to movies via internet. 2007 was determined to be the start of the revolution and 2009 the beginning of maturity.

    And where is the mention of Verizion’s FIOS? Millions of people now use it, but it’s like a great big secret. Check that one out Mr. Reporter. Downloads coming at you at the speed of fiber right to your door. Unlike Comcast the only has a partial fiber network. HD movies direct to your TV in minutes via FIOS. Not hours to your PC. And yes, there are methods of sending those Netflix movies over to your TV, but most are too complicated and, of course, there is the added cost. And the current internet infrastructure is still not ready to download a movie to your PC in minute.

    Netflix, Blockbuster and any company delivering movies by mail or to your PC are on the way out in 2009. Just like the combustion engine has now seen its day with many auto makers making plug-in vehicles available in 2010. They won’t be gone, but they’ll be on their way out. Why? Netflix missed an opportunity that was right in from of Hastings face. And that one I’ll keep to myself.

    Meanwhile, the merging of the TV and the PC has already started. Just see how DirecTV, Dish, cable companies and FIOS work. A small PC doing all the work and the TV is now just the monitor.

    I did miss out on CinemaNow and MovieLink (now owned by Blockbuster). Both have been around much longer than Netflix doing downloads to the PC. But who knew? No money for ads. Run by studios testing the waters. All the venture capital for this industry went to Netflix. They all got their money and then some. But technology always passes you up if you can’t see the real future. Sorry Reed. Your days are number.

    Now there is a more complete article. Did I miss any other service? Think not!

  • Report this Comment On October 08, 2008, at 11:21 AM, johnfstephjr wrote:

    A FOOL and his money, will soon be parted!

    Foolish fools!

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