(Updates with closing stock price.)
Sept. 20 (Bloomberg) -- Netflix Inc.’s decision to split its DVD operation from the flagship streaming service isolates the shrinking mail-order business and paves the way for an eventual exit, analysts said.
A pure-play online business would be smaller and faster- growing, with more freedom to experiment, said George Askew, an analyst with Stifel Nicolaus & Co. in Baltimore.
“The separation of online streaming and DVDs will set the stage for spinning off or selling the DVD business in the future,” said Askew, who has a “hold” rating on the shares.
Netflix has plunged 38 percent the past four trading days as investors react to cuts in the Los Gatos, California-based company’s subscriber forecast and plans to separate the mail- order DVD business into a service called Qwikster. Netflix appears to be “actively trying to push people away” from the disc business, said Tony Wible, an analyst with Janney Montgomery Scott LLC in Philadelphia.
The DVD and streaming units have evolved differently, said Rich Greenfield, an analyst at BTIG LLC in New York.
“One business is global, one is domestic,” Greenfield said. “One is based on physical media and the other on digital. It’s about aligning the business up and down.”
Netflix said it has no plans to exit mail order and that the split reflects different growth trajectories. In a weekend blog post announcing the changes, Chief Executive Officer Reed Hastings apologized to customers over the handling of a July price change that boosted the monthly cost by 60 percent for subscribers who stream movies and rent DVDs by mail.
“It is clear from the feedback over the past two months that many members felt we lacked respect and humility in the way we announced the separation of DVD and streaming, and the price changes,” Hastings said.
Netflix fell $13.72, or 9.5 percent, to $130.03 at 4:29 p.m. New York time in Nasdaq Stock Market trading. The shares have declined 26 percent this year after more than tripling in 2010 and almost doubling in 2009.
Not everyone expects a sale. Wible, the Janney Montgomery analyst, puts the odds of a sale or spinoff at less than 50 percent, because of the difficulty finding a buyer or investors who would want stock in a mail-order DVD rental company.
The mail-order business is worth eight to 10 times earnings, or about $20 per Netflix share, said Wible, who has a longstanding sell recommendation on the shares.
“I think you’d find a lot of skepticism, like the Postal Service trying to do an IPO right now,” Wible said. “There are issues that are only going to get worse.”
Hastings wants to speed up consumers’ migration from physical rentals of discs to streaming of movies and TV shows. About 12 million of Netflix’s 25 million-plus customers use both the mail-order and streaming service.
Like Music, Like DVDs?
The Netflix CEO also suggested the mail-order business, while shrinking, has a long run ahead of it. On a July conference call, he estimated the DVD business may decline by 10 percent a year.
“What we do know is that we are going to maximize whatever opportunity is there,” Hastings said on July 25.
Netflix cut its third-quarter subscriber forecast on Sept. 15, two weeks after the price change took effect. The company trimmed its estimate of domestic DVD-only subscribers to 2.2 million from 3 million and said U.S. streaming-only users would total 9.8 million, down from the 10 million seen earlier.
With the split, subscribers who want to remain customers of both businesses will have to use different websites to order from each. Qwikster, which plans to offer video-game rentals, will also bill separately.
The division could alienate users attracted to the convenience of a single site for finding DVDs and streaming, said Michael Olson, an analyst with Piper Jaffray Cos. in Minneapolis. He has an “overweight” rating on the shares.
Separating the two businesses may also signal Hollywood is gaining the upper hand in negotiating streaming rights, according to Bill Gurley, a partner with Benchmark Capital who blogs at abovethecrowd.com.
Given studios’ demands to be paid per user, Netflix probably separated the businesses so it wouldn’t have to pay for subscribers who don’t stream, Gurley said in a blog post.
The danger is that Netflix may weaken both businesses, especially after the company lost access to Sony Corp. movies from Starz, part of John Malone’s Liberty Media Corp. empire.
“If anything, the streaming service is probably weaker today than it was three months ago,” said Youssef Squali, an analyst at Jefferies & Co. with a “hold” rating on the stock.
--With assistance from Andy Fixmer in Los Angeles. Editors: Rob Golum, Anthony Palazzo
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