A leading provider of online movie rental services, Netflix Inc. (NFLX) recently announced new subscription plans for its DVD-by-mail and streaming customers. Under the new plan, customers who seek to subscribe for both the DVD-by-mail and streaming services will have to pay $16.00 per month for unlimited access. Previously, Netflix used to charge $10.00 a month for the bundled offering.
Netflix announced that the unlimited streaming only plan will remain at $8.00 per month. However, to get an add-on DVD along with the streaming service, customers will have to pay an additional $8.00. Previously, the company used to charge $2.00 for the same. Further, customers who want to hire two DVDs will have to pay an additional $12.00 per month while to hire three the customer has to pay $16.00 per month.
The new rates will be effective for new subscribers immediately. However, for existing customers, the rates will be effective September 1, 2011. We believe that the higher rates may hurt subscriber growth in the near term.
Just a few days back, Netflix unveiled a new DVD-only subscription plan for $8.00 a month. Previously, Netflix subscribers had to pay $10.00 for unlimited DVD rentals and subscription access or $5.00 for just two DVDs per month.
Netflix, which started off as a DVD-by-mail company, has achieved significant subscriber growth in the US. As of March 31, 2011, the company’s total subscribers (Domestic and International) increased by a net 3.6 million sequentially and by 9.6 million year over year to 23.6 million.
This strong subscriber growth was primarily driven by Netflix’s growing streaming business. Over the last 12-18 months, the company had been shifting away from its original DVD rental business and primarily focusing on online streaming content. This was primarily due to the fact that DVD rental is a low-margin business compared to online streaming given the high postage and sorting infrastructure costs.
However, Netflix’s DVD customer base is also significant and its DVD rental business is massively popular. This is mainly due to Netflix’s huge DVD library, which boasts more than 100,000 titles compared to 20,000 titles available for streaming. Moreover, new theatrical releases that may not yet be available for streaming are also readily available on DVDs.
We believe these factors may attract new DVD-only subscribers (especially those who either don’t have access to broadband service or are not interested in Netflix’s streaming content) or may push existing customers to subscribe for the new DVD only plan as they will pay a reduced rate ($8.00 instead of $10.00). This can cannibalize streaming content sales in the near term.
Moreover, Netflix’s streaming service suffered a heavy blow recently, when Sony Corp. (SNE) stopped streaming of its films, as a deal renegotiation with Liberty Starz Media fell through. This may also prompt existing or new subscribers to go for a DVD-only plan.
However, over the long term, we believe the increasing focus on the digital video service will be the key growth driver for Netflix. Higher adoption of mobile and tablet devices coupled with increasing broadband penetration will be the primary reason behind this, in our view.
Netflix continues to add content to its already vast and varied library, through partnerships with big production houses like Paramount Pictures, Twentieth Century Fox and Miramax films. Although rising license fees is a concern and could very well impact margins, we believe these partnerships will drive rapid growth in the subscriber base, which will offset any negative impact on margins. Moreover, a decline in postage and sorting costs due to lower DVD shipments will boost margins going forward.
We also believe that these content additions will enable Netflix to reduce its dependence on cable TV operators and also provide the necessary competitive edge over its peers in the emerging market of online video streaming.
Our Take
Although the rise in subscription rate is a shocking move for DVD customers, we don’t expect Netflix to lose significant market share in the near term. This is primarily due to Netflix’s diversified content and huge video library due to partnerships with Hollywood studios compared to its peers.
However, intensifying competition from large players such as Amazon.com Inc. (AMZN), Apple Inc. (AAPL) and Google Inc. (GOOG) in the online streaming market is a headwind because it will further push up license fees and also affect subscriber addition.
Netflix intends to expand its business into new territories going forward. Recently, the company announced its plan to launch Internet movie subscription service in Latin America and in the Caribbean. However, we expect margins to remain under pressure due to higher expansion costs in international markets.
We maintain our Neutral recommendation on Netflix over the long term (6-12 months). Currently, Netflix has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.
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