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Not a drill

25 October 2011 By Robert Cyran

The Netflix story of triumph has turned quickly into something more like “The China Syndrome.” Like the nuclear disaster depicted in the 1979 film, the company’s core, where profit is concerned, is melting down.

Up till now, Netflix has been cagey about the respective profitability of the two units it was planning to separate. New figures show Netflix makes about 10 times more from a DVD customer than an online streaming subscriber. Trouble is, the wrong arm is shrinking – and fast.

The future for Netflix was always in streaming. There’s no reason to wait for a DVD in the mail when a movie can be delivered instantly to the TV. Still, many subscribers complained angrily when Netflix outlined plans earlier this year to split the two businesses. The company reversed itself, but extra related disclosure proceeded.

The new numbers reveal that while money-losing international businesses are growing, far larger domestic operations have hit a wall. Netflix reckons it could lose as many as 7 percent of its streaming subscribers this quarter. Worse, up to 3.6 million of its 13.9 million DVD subscribers could flee by the end of the fourth quarter, too.

Netflix says profit from U.S. DVD rentals should be between $177 million and $192 million. It will only make $30 to $42 million on streaming, even though there are twice as many buyers of the service.

A recent price increase undoubtedly exacerbated the loss of the wrong sort of customers. Many opted for streaming only to save cash. But even Netflix admits DVDs are a dying business. The associated profit will deflate in time anyway. Profit from streaming could grow as subscribers are added, but the cost of programming is rising and the competition is stiffening.

Small wonder Netflix lost more than a quarter of its market value in late trading on Monday, after falling about 70 percent from its high in July. The company still trades at about 20 times estimated earnings for this year. After estimates are slashed following the latest revelations, Netflix will still command a premium valuation. But with its biggest source of profit evaporating, the company’s shares no longer deserve one.


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