Netflix’s stock plummeted in after-hours trading on Monday, revealing persistent unease about the future of the company and doubts about the viability of its business model.
Once the darling of the home entertainment industry, the company has had a brutal year, thanks to a series of major missteps in its attempt to transition from discs to streaming.
The negative response to a better-than-expected earnings report didn't do anything to dispel worries that a major bounce-back remains elusive.
With its subscriber base not growing as some had hoped, CEO Reed Hastings (pictured below) continues to bank a recovery on an expansion internationally and investment in more original programming, like the upcoming highly anticipated revival of "Arrested Development."
But those cost money, which, without ad revenue, necessitates a constant and robust influx of new subscribers.
Currently, Netflix boasts 23.4 million domestic subscribers. Another 3 million are international.
Netflix’s current share price “is based on some unsustainable growth view that it can grow 6, 7, 8 million domestic streaming subscribers a year,” Michael Pachter, an analyst with Wedbush Securities, told TheWrap.
“They have to believe there’s a greater fool out there who’ll take whatever crap Netflix throws at you. But there are not many millions more of those people.”
When Netflix’s earnings call on Monday opened with a question about its subscriber projections, the company estimated 7 million for the year. Yet while it added 1.7 million domestic subscribers in the first quarter, its projection for the second quarter was underwhelming: fewer than in the same frame from 2010.
Trouble is, analysts want to see continued growth, not a decline. If the numbers are going down, how are they getting to 7 million by year’s end?
Hastings and Wells said growth figures were consistent with “historic patterns” and talked a lot about subscriber growth being seasonal.
When TheWrap followed up with Netflix spokesman Steve Swaysey, he said much the same thing, adding that the second quarter is usually the worst for adding subscribers.
Then why did the company’s stock price fall?
“The business is growing," he said. "We had a terrific quarter, but some people did not fully understand the seasonal metric we provided.” Translation: It's everyone else's fault.
Make no mistake, Netflix’s future is about that subscriber number.
“If they can get incremental subscribers, it can be a highly profitable model, but it’s hard to predict quarter to quarter,” Aaron Kessler, an analyst with Raymond Jones & Associates, told TheWrap.
Kessler believes the peak on subscribers is 40 million. That’s a far cry from the 60 to 90 million Hastings has said Netflix could attract.
One reason Netflix’s growth may hit a wall is the rise of challengers. Hulu and Amazon both stream movies and TV shows — and Hulu actually offers in-season shows, not available on Netflix. What's more, Hastings said on Monday he still expects Jeff Bezos & Co. to launch a standalone streaming service.
Adding to the competition, Verizon and Coinstar, owner of Redbox, just announced a partnership that many see as a threat.
Meanwhile, Netflix’s partners in all of this – the studios – continue to demand more to justify handing off their libraries, forcing renegotiations such as the one that caused Netflix to lose its massive deal with Starz. That deal included a large number of Sony films.
Pachter says Netflix has to raise the prices for its streaming service to work. “Their business model is broken because they have ordained that the price you will pay for unlimited streaming is $8 a month,” he said.
And raising the prices right now is not an option. Last time Netflix changed its pricing, trying to spin off the DVD business as a separate business called "Qwikster" — last summer — it spawned an animated consumer backlash that persisted as Hastings made a series of public-relations missteps.
“The brand is recovering well, but we still a ways to go," Swaysey said. As part of sustaining that recovery, Hastings said Monday that the company would not be raising prices.
The only choice left is to try to add subscribers, and with a growing crop of rivals, the company has to differentiate itself. Thus, the investment in original series, following in the footsteps of premium subscription channels like HBO and Showtime.
The first, “Lilyhammer,” a mob series starring E Street Band-er and "Sopranos" alum Steven Van Zandt, launched in February.
Coming up are "Arrested Development," with the original cast returning for 10 shows and talk of a several-season future; “House of Cards” from David Fincher, starring Kevin Spacey; and the Eli Roth-produced "Hemlock Road."
Of course, all of these take money to produce; without ad revenue, the company has to hope the offerings will bring in enough new subscribers to foot the bill. The company has so far refused to release any ratings on "Lilyhammer."
Another one of Netflix’s approaches is taking on the international market. It has already launched in the U.K., Ireland, Canada and Latin America.
Its paid international subscriber base grew by almost 1 million in the quarter, and analysts agreed that both Canada and the U.K. could be fruitful new bases. But Latin America has proven to be a bit more difficult.
“The odds of us building a large, profitable business in Latin America are very good, but it will take longer than we initially thought,” Hastings and Wells said in a letter to shareholders.
And these new expansions do more than boost Netflix’s cache. They cost money. To pay for that, the company needs more subscribers.
Sounds like we’re back at the start of the problem.