A leading provider of online movie rental services, Netflix Inc. (NFLX) unveiled a new DVD-only subscription plan for $7.99 per month. Previously, Netflix subscribers had to pay $9.99 for unlimited DVD rentals and subscription access or $4.99 for just two DVDs per month.
The new subscription plan is targeted at those customers who either don’t have an access to broadband service or are not interested in Netflix’s streaming content.
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 the rental DVD service is a low-margin business compared to online streaming given the high postage and sorting infrastructure costs.
The transition has catapulted Netflix from primarily a DVD-by-Mail company to a premier online streaming company, as net subscriber additions were 7.7 million at the end of 2010, compared with 2.9 million in 2009. Net subscriber additions also surpassed management’s target of 3.6 million for the year.
As of March 31, 2011, the total number of 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 success prompted Netflix to further focus on streaming services in lieu of DVD rental business. Earlier, Netflix removed the “Add to DVD Queue” feature from its user interface on streaming devices. Netflix said that the removal of the feature will reduce complexities and free up resources, which in turn will improve the overall streaming functionality. However, this move was heavily criticized by DVD rental subscribers.
Analysts believe that the renewed focus on the DVD business is important for Netflix, as it hedges a potential loss of streaming content. Netflix 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.
Our Take
We believe the new subscription plan reflects a slight change in Netflix’s operational strategy, as it re-establishes the importance of the DVD business in Netflix’s business model. We believe the new strategy will further boost subscriber base and will also keep a check on churn rate growth going forward.
Moreover, Netflix remains focused on becoming an entertainment powerhouse by adding content to its already vast and varied library through partnerships with big production houses like Paramount Pictures, Twentieth Century Fox and Miramax films.
We 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.
However, the intensifying competition from large players such as Amazon.com Inc. (AMZN), Apple Inc. (AAPL) and Google Inc. (GOOG) in the online streaming market is significant 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 the 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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