Netflix Investors: Don't Be Wooed by an Earnings Beat
NEW YORK ( TheStreet) -- Netflix(NFLX) is expected to report some subscriber recovery in the fourth quarter, which should lead to better-than-expected results. But investors should be wary about reading too much into an earnings beat.
"Netflix is poised to see a rebound in subscribers and may be in a good position to beat conservative revenue estimates, which should help fuel a near-term rally in the stock," Janney Capital Markets analyst Tony Wible wrote in a note. "However, our analysis shows that the company's guidance is reliant on DVD subscribers opting for multi-disc plans and suggests that the Street may be too aggressive in modeling Netflix's recovery."
Ultimately, this could lead to downward estimate revisions if management doesn't issue guidance materially above Wall Street's first-quarter estimates.
While analysts for the most part are expecting modest upside to fourth-quarter results, before investors get more confident in Netflix's turnaround story they should hold out for color on the true "scalability" of the streaming business and any details on just how much international growth will pressure the bottom line.
Netflix lost about 800,000 subscribers in its third quarter following the implementation of higher prices. "The key question is whether U.S. Netflix subscribers have started to re-engage with the service, especially those subscribers who churned off," noted Citi analyst Mark Mahaney.
It seems Netflix is banking on many DVD-only subscribers opting for more expensive two and three-disc out plans, as implied in its average retail per user guidance for the quarter, Wible said.
"This may be aggressive assumptions in light of Netflix subscribers having shown to be price elastic, cheaper disc rental alternatives and the massive growth in streaming hours may suggest more DVD subscribers are moving to streaming and are less reliant on discs," Wible wrote.
Netflix said earlier in the month that users streamed 2 billion hours of movies and television shows during the fourth quarter. While this is an impressive stat, streaming has proven to be a low-margin business that must compensate for the much higher-margin DVD business.
Wible estimated that Netflix needs at least four streaming subscribers to account for the loss of one DVD user.
Bernstein Research analyst Carlos Kirjney said he expects domestic streaming margin should expand to 18% over the next three years from about 8% currently. But he believes this growth will be offset by erosion in the DVD business, estimating DVD subscribers in the U.S. will fall to 4.6 million by the end of 2016 from 10 million in the first quarter of 2012.
"We still believe the key issue for bullish or bearish investors should rest with Netflix's ability to scale the streaming business, increase price (again) and/or layer on new services," Wible wrote. "Without these incremental earnings drivers, we believe investors will find that Netflix does not generate nearly as much value per subscriber as it did only a few years ago. The rebound in subscribers may act as a near-term catalyst for the stock, but the first-quarter guidance will be paramount as it could trigger more earnings revisions."