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The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
Netflix (NASDAQ:NFLX) will report Q3:12 (September) results after the market close on Tuesday, October 23, and host a conference call at 3:00pm PT (Dial-in: 760- 666-3613, webcast: http://ir.netflix.com).
We expect Q3 results within the guidance ranges, but below our estimates. Our estimates for revenue of $915 million and EPS of $0.10 are above consensus of $905 million and $0.04 and guidance of $890 – 911 million and $(0.10) – 0.14. It appears that Netflix increased marketing spending as the quarter progressed, hurting profitability. We believe this was an effort to approach the high end of Q3 Domestic Streaming subs net adds guidance of 0.96 – 1.76 million, but we expect the company to fall well short of 1.76 million, particularly given the Summer Olympics. Management previously disclosed it would be on track to achieve fullyear subs guidance of 7 million if Q3 net adds were in the high end of the range.
We expect Netflix to lower its unrealistic full-year Domestic Streaming subs net adds guidance of ≈ 7 million. With 1.74 million Domestic Streaming net adds in Q1 and 0.53 million more in Q2, Netflix must add approximately 4.73 million over the second half of the year to hit its target. This implies a 32/68 split between 1H and 2H, even more aggressive than its historical 41/59 split. However, with Q3 likely coming in below the high end of guidance, we expect Netflix to provide a more achievable range of 5 – 6 million, hoping Nintendo’s Wii U launch can boost subs. However, we think the bulk of Wii U buyers already have Netflix accounts.
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We believe the Street is overstating the value of Netflix’s Domestic Streaming segment by focusing on Contribution Profit. We believe there has been an over-allocation of Cost of Revenues and Marketing Expense to International Streaming (already viewed as a low-profit segment, at least in the near-term) and an under-allocation to Domestic Streaming, resulting in overstated profitability. In addition, (1) Technology and Development and (2) General and Administrative expenses need to be considered before assessing profitability. We believe that a proper allocation of these line items would result in a Domestic Streaming segment that is much closer to operating at break-even or at a loss, hurting valuation.
Maintaining our UNDERPERFORM rating and 12-month price target of $45. Our price target is 15x our sustainable EPS estimate of $3, which we believe is attainable only if Netflix forsakes growth at all costs and raises prices.
Michael Pachter is an analyst at Wedbush Securities.
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