Is Netflix in for Another Year of Pain?

Shares of Netflix (Nasdaq: NFLX  ) are approaching two-year lows today after a bearish analyst note.

Bank of America Merrill Lynch warns of "another year of pain" at the video service giant, lowering its profit target as the vicious cycle of throwing domestic streaming profits at international expansion continues. If that doesn't pan out, Netflix will probably be able to improve its profitability by giving its passport a rest -- yet that would also imply that its core business is teetering.

In short, it seems as if Netflix can't win in either scenario.

Netflix's latest quarter shows the problem with its aggressive overseas push. Netflix may have achieved a contribution profit of $67 million in its domestic streaming business during the first three months of this year, but that was more than offset by a $103 million shortfall in its international streaming unit.

Going big overseas doesn't come cheap, and the $103 million in contribution deficit during this year's first quarter was as much as Netflix recorded as a deficit there for all of 2011.

Netflix can't turn back now. Its domestic streaming business will get harder to grow at this point, forcing it to smoke out growth abroad. There are already 23.4 million Netflix streaming accounts in this country. How much better can that get?

The addressable market is huge, but the competition is coming.

  • Verizon (NYSE: VZ  ) and Redbox parent Coinstar (Nasdaq: CSTR  ) have a new digital service rolling out later this year.
  • Amazon.com (Nasdaq: AMZN  ) continues to add to its streaming library of titles that it lets Amazon Prime members access at no additional cost.     
  • If and when Apple (Nasdaq: AAPL  ) introduces a full-blown Apple HDTV, it would be nuts for it not to go from simply offering piecemeal rentals through iTunes to an unlimited service that owners rely on perpetually.

Netflix shares shed more than 60% of their value last year, and it's hard to see things getting even worse this time around. Yes, things look bad here, but there's one scenario that Merrill Lynch and other naysayers are forgetting: Netflix may turn a profit at its highly scalable international operators sooner rather than later.

Stream on
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The Motley Fool owns shares of Amazon.com, Apple, and Netflix. Motley Fool newsletter services have recommended buying shares of Apple, Amazon.com, and Netflix. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Longtime Fool contributor Rick Munarriz has been a Netflix subscriber and shareholder since 2002. He does not own shares in any of the other stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.


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  • Report this Comment On May 31, 2012, at 6:35 PM, AceInMySleeve wrote:

    I don't understand:

    a) The path to profitability at a place like UK. How does Netflix look at it? They don't ever say. They are only marginally productive at the tremendous monopolistic scale they have here. In the UK, their chief adversary has a DVD service to complement which is ironic.

    b) Why international expansions are constrained by global profitability. These are two entirely independent concepts. Your decisions on a place like UK are based on the possibilities and risks in the UK. The only other issue I can think of is they are concerned about cash status and financing strength in relation to negotiations with studio partners. That's a possibility I suppose, but it doesn't scream like they see opportunity. If they did, it would be foot to the floor.

  • Report this Comment On May 31, 2012, at 6:45 PM, AceInMySleeve wrote:

    I wonder if it's overblown that LoveFilm is winning exclusive contracts. Assuming they are both spending a good amount of money on content, the value proposition for customers choosing both services is quite strong. People are certainly used to getting their flix from multiple sources, and so presumably if they pay twice as much they are still getting twice as much content. Plus multiple competing services seem to get benefits in terms of free marketing as outlets rush to compare and contrast (something that's not possible with 1 customer choice).

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