Good News for Netflix

A strong report pointing to a buoyant fourth quarter further cheered investors after Blockbuster bowed out of cheap monthly subscriptions

by Arik Hesseldahl

Anyone looking for reasons to be bullish on Netflix got plenty of them on Oct. 23. Early in the day, Netflix rival Blockbuster said it would stop offering a service that lets customers rent two videos a month for $5.99, its lowest monthly subscription rate and the same price as a competing service from Netflix.

Blockbuster (BBI) was mum on its reasons, but analysts saw the decision as an indication that the price wasn't a big hit with customers. The change leaves Blockbuster's lowest plan at $7.99 a month, and gives Netflix (NFLX) bragging rights to the lowest-priced monthly plan.

Worth Cheering?

Some analysts weren't sure the distinction is much to brag about. "Once you get that low, you run into diminishing returns," says analyst Frank Gristina at Avondale Partners in Nashville. "At that price you aren't getting the customers who are renting enough to make it worthwhile."

Gristina says that while Netflix doesn't disclose the distribution of subscriptions to its various plans, he suspects that as many as 25% of its customers use the $9.99 monthly plan, and that few use the $5.99 plan because those who would normally consider it are generally infrequent movie renters. As such, they're more likely to rent from local video stores like the corner Blockbuster. "I don't see Blockbuster canceling its $5.99 service as being a catalyst for Netflix in either direction," Gristina says.

Still, something got the Netflix stock moving skyward. The shares rose 84 cents, or nearly 4%, to close at $23.08 a share.

More Good News

The stock then soared in extended trading, up $2.90, or more than 12% on a quarterly earnings report that handily beat analyst expectations. The company reported earnings of $12.8 million, or 18 cents per share, an 84% improvement on the year earlier. Revenue was $256 million, up 48%. Profit beat analysts' expectations of 12 cents a share, while revenue beat their forecast of $251 million. Netflix said it finished the quarter with 5.66 million subscribers, compared to 3.6 million a year earlier.

Looking ahead, there was more reason for cheer. The company said it expects to exit the fourth quarter with 6.3 million subscribers, and sales of $273 million to $278 million in the final three months of the year. That compares with $272.3 million expected by analysts. Netflix forecast earnings of 8 cents, matching the consensus estimate. Netflix has a five-year target to reach a customer base of 20 million subscribers.

But analysts aren't sure what 2007 holds for Netflix. Specifically, they're hungry for news on Netflix's plans for a digital download tool that will compete with services like Apple Computer's (AAPL) nascent movie download service on the iTunes Store, as well as other services like CinemaNow and MovieLink (see BusinessWeek.com, 9/12/06, "Don't Nix Netflix Just Yet"). "There's been some chatter that Netflix will do some kind of set-top box with someone like Motorola (MOT)," says analyst Chad Bartley at Pacific Crest Securities in Portland, Ore. "There's very little consensus on what the plan might be."

Hesseldahl is a reporter for BusinessWeek.com.