3 Things Netflix Needs to Say

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The S.S. Netflix is taking on water.

Shares of Netflix (Nasdaq: NFLX  ) sank after posting disappointing quarterly results. Between the lackluster subscriber growth outlook and more mailer-red ink on the horizon, it's hard for investors to sit through this painful screening.

However, you've probably had your fill of Netflix negativity. Let's take a look at a few things that CEO Reed Hastings could say that would make things better.

1. "We will no longer sacrifice near-term profitability for the sake of international expansion."
One of the sticking points in Netflix's report is that it may crank out a small profit during the current quarter, but it's warning of a small deficit during the fourth quarter.

The culprit would be the company's push into a new European country later this year.

Sure, it makes sense to expand internationally. There aren't too many companies doing this right, giving Netflix the mother of all land-grab opportunities. After lining up enough Spanish and Portuguese content for its Latin American rollout, hitting up Spain or Portugal is completely logical.

However, investors didn't appreciate the quarterly loss that Netflix incurred when it threw itself into Ireland and the U.K. several months ago.

Citigroup analyst Mark Mahaney issued a bullish note earlier this month, arguing that Netflix was trading for just 12 times the profitability of its domestic operations. International losses are blurring the fundamental strength in the company's stateside business.

It may be great to see Netflix build up its international business to 3.6 million subscribers in two years, but give investors the fiscal responsibility that they expect. Make it clear that this will be the last international expansion that sinks Netflix into the red. If not, investors will never trust quarterly profitability as being sustainable. The stock will continue to be held back in fear of the next international hit.

2. "Our DVD-based business may not decline every quarter."
One of the more shocking admissions by the company is that disc rentals are on a downward spiral.

"We expect DVD subscribers to decline steadily, every quarter, forever," Hastings told an analyst during January's conference call.

We all know that this is a niche in decline -- especially since Netflix is practically abandoning its flagship specialty -- but every quarter?

The numbers are certainly bearing that out. Since peaking at nearly 15 million last summer, Netflix has shed roughly 10% of its DVD subscribers every passing quarter. Yes, it's that bad. Netflix shed 850,000 disc-based customers during the past three months alone.

It's easy to blame the fading popularity of the optical disc for the slide to just 9.2 million DVD accounts, but why is Coinstar's (Nasdaq: CSTR  ) Redbox still growing?

There's a market worth cultivating here. Coinstar and DISH Network's (Nasdaq: DISH  ) Blockbuster are still around because they have gone on to add video games as they opportunistically take advantage of fallen rivals. It may seem to be too late for Netflix to add video games the way it briefly promised during last summer's Qwikster fiasco, but that would be one way to retain customers who are getting more physical-media variety eslewhere.

3. "$7.99 a month is the floor -- and not the ceiling -- of what Netflix is capable of acheiving."
Netflix closed out the second quarter with a whopping 30.1 million subscribers. That's a great number. Netflix has more subscribers than any satellite-television or cable provider. It has also surpassed Time Warner's (NYSE: TWX  ) HBO to become the top premium subscription channel.

The problem is that more than two-thirds of those subscribers are paying the company just $7.99 a month for its streaming service. There's little upside to that in the model. It's not like the old days, when folks would upgrade to multi-disc plans costing more than $20, or when the company would sell previously viewed DVDs to members.

Netflix needs to change that perception.

One way would be to offer a la carte digital rentals of new releases. I've been hammering this point for months, and it continues to make sense. (Nasdaq: AMZN  ) and Blockbuster already offer this in addition to the older titles that are part of their streaming catalogs, but they have to gain traction. Amazon is still too behind in terms of appliances that stream Amazon's digital video, and Blockbuster's streaming service is available only to DISH Network customers. Netflix has a real shot to make a difference here, whether it teams up with Apple's (Nasdaq: AAPL  ) iTunes or rolls out its own platform.

Netflix's stock will never approach last summer's all-time highs as long as the model is perceived to be capped in terms of average revenue per user. The addressable market and $7.99 a month will only take Netflix so far, and it's time to get excited about the ceiling rather than stare at the floor.

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The Motley Fool owns shares of Apple, Netflix, and Motley Fool newsletter services have recommended buying shares of Netflix, Apple, and and creating a bull call spread position in Apple. We Fools don't 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 owns noneof the other stocks in this story and is part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 26, 2012, at 11:56 AM, StopPrintinMoney wrote:

    Thanks. It reminded me when Coutrywide was two inches away from the hole, but the CEO made a statement that the company will do just fine. The stock literally more then doubled...

    The markets will believe whatever they're told, cause they're inefficient.

  • Report this Comment On July 26, 2012, at 2:27 PM, OceanJackson wrote:

    I've been a Subscriber of Netflix's service since 2000 - 12 years. I've owned NFLX stock for the majority of its Public existence. I grew up in Los Gatos where Netflix is headquartered. I have friends that have worked there a long time. No one knows Netflix better than me. I am Netflix's man on the street. If Reed Hastings would just listen to ME - the stock could completely be turned around. And I can't get my message to him. So listen up everyone. All the talk lately's on Subscriber Counts, International Expansion Costs, & Content Acquisition....But do you want to know what the insider key to success is? It's the kind of subscriber loyalty and fandom that Netflix HAD for the 1st 10-11 years of it's existence, that it lost over the last 3. The Subscriber Bond to the service was the Rock on which everything sat. Reed - make us love you again and profits and growth will blow through the roof. It wasn't Qwikster, it wasn't price hikes - that alienated us, but those were big F You's. The little spoken truth is that Netflix lost it's rabid fanbase with smaller things. These were things that longtime Netflix subscribers, the core base that recommended the service to every single person they knew - loved and valued about the service. Netflix used to have a Social aspect to it. I used to be able to be 'Friends' with my Brother, Mother, Girlfriend...and anyone else I knew that used Netflix, a lot of people. I used to be able to look at what they'd watched, how they rated it, go through their queue's, and what they had at home currently. I got a lot of ideas of what to add to my queue, and it served as a frequent conversation point. Netflix faciliated it's own marketing in this way. You also used to be able to see what ratings you had in common with them, where you really disagreed, and overall - how similar % wise, your taste in movies were to them. This aspect of the service united us. It united the fans...and counterintuitively, it even did so for the subscribers who barely used that part of the service because they still felt like part of a group. One day this feature just VANISHED. No warning, nothing. When I called customer service, they said "it's not coming back, it took too much SERVER SPACE." Man what a WEAK excuse. The next thing to happen was Netflix took away the other Social aspect to its service - the reviews identities. You can still write reviews and see all the reviews for films and T.V. that have ever been written on the site. But you used to be able to see who had written them. You could add an Icon/Photo to your profile and it appeared next to your review. I could read your review, click on your photo and i.d., and see your other reviews, see how similar my movie tastes were to yours, etc. This added to my time spent on the site, resulting in more additions to my queue, more fiddling around with the queue, and all the while subconsciously - growing my addiction and love of Netflix. So if you want to know the Real Story of Netflix, it's not in the quarterly reports, it's not in media coverage - it is this: When Netflix was at $300 a share, it was riding the cost savings of cuts to their service like these, at the expense of the goodwill of it's ultra-loyal customer base (I'm talking the kind of loyalty hardcore fans of a sports team have). When the fan base was at the end of its rope, when we felt abandoned, used, and left out in the cold - i.e., Qwikster & price hikes (for not just fewer DVD's per month, or lesser Streaming Hours - but for a lesser Website Service) cut the umbilical cord completely, like a parent abandoning it's child on the side of the road, the stock plummeted. As with any stock, there's the story of what you see on the surface, and the story of what really happens underneath. The bottom line is, everyone thinks Netflix could differentiate itself and beat Amazon, Hulu-Plus, RedBox etc...with more and better streaming Content. This is important. But what Netflix really needs to do, is make us love them again. There is SO MUCH they Reed Hastings can do to make his subscribers happier via features of the service that they aren't doing. I no longer have a good experience on the Website. It's very Corporate and cold. Well hey Reed, you saved money, but look at what it's costing you. You might very well end up losing the end-game because of it. I haven't recommended your service to anyone lately. I still use it because - it's a value, and is still the best option. But I'm not excited about it. I'm not surprisingly happy with it like I used to be, for 10 years in a row. You're a growth company right? You need more subscribers right? How are you going to get that 7 Million figure you need this year without someone like me recommending Netflix and talking about it to dozens of people? It's such an easy fix Reed. Bummer. And that loyal base is still there, like an ember underneath the ashes waiting to be kindled again. That's your key to success.

  • Report this Comment On July 26, 2012, at 3:15 PM, acb29 wrote:

    What is the real challenge for Netflix is content costs and content distribution rights. The content providers are in bed with cable companies and do no want the Netflix model to succeed, so tney jack up their rates, when it comes time to renew Licenses. Also the platform providers (xbox , Sony etc.) , all have agreements with Netflix that LIMIT what new content (movies, etc) they can show, so as not to compete with the platforms native media store. These are the two core problems Netflix needs to solve. They have a great distribution network , but will continue to lose subscribers unless they can solve the content issues. I think something bold like offering Live sports, or popular live one-time events (concerts / shows) will provide a foothold on existing and new customers.. my 2cents..

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