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The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
Q3 beat from better-than-expected revenue growth and cost control. Revenue was $905 million, compared with our estimate of $915 million, consensus of $905 million, and guidance of $890 – 911 million. EPS was $0.13, compared with our estimate of $0.10, consensus of $0.04, and guidance of $(0.10) – 0.14.
Domestic streaming net adds guidance lowered by a larger-than-expected amount. Management lowered full year net adds guidance to 4.73 – 5.43 million, well below the 7 million guidance it has provided all year. The magnitude of the Q3 miss was only 0.6 million, with guidance lowered by 1.57 – 2.27. Most importantly, Netflix (NASDAQ:NFLX) has steadfastly claimed that its content costs are “fixed” (we disagree), meaning that contribution profit will be significantly lower than consensus in 2013.
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Decreasing our FY:13 estimates. We are decreasing our 2012 estimate for revenue to $3.59 billion from $3.65 billion, but are increasing our EPS estimate to $0.07 from $0.03 to reflect guidance and better-than-expected profitability. We are decreasing our 2013 estimates for revenue to $4.03 billion from $4.25 billion and for EPS to $0.00 from $0.50 as sustained profitability will remain elusive due to lower overall domestic subs and additional international expansion.
We do not see many catalysts for continued domestic streaming growth. In our view, Netflix has already converted the vast majority of potential streaming subscribers on mobile devices, consoles, and smart TVs into paying subscribers. We view next month’s launch of the Nintendo Wii U, the next generation of consoles (to be released in 2013 or 2014), and additional iterations of mobile phones and tablets as inconsequential drivers of growth.
Netflix has sacrificed profitability to focus on global expansion. Management expects Q4 EPS of $(0.23) – 0.04 due to its recent Nordics launch, meaning estimated implied full year guidance is for EPS of $(0.07) – 0.20. Therefore, Netflix could have losses in two quarters of 2012 (Q1 and likely Q4), with a potential loss in 2012 and another loss likely in 2013 after making over $4 per share in 2011.
Maintaining our UNDERPERFORM rating and 12-month price target of $45. We value domestic streaming at $15, domestic DVD at $20, and assign a speculative $10 option value to international streaming. Our price target is at risk if domestic streaming growth slows more than we have modeled, or if the domestic DVD segment loses more subscribers than we currently have modeled.
Michael Pachter is an analyst at Wedbush Securities.
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