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Analyst Downgrades Netflix

24 Nov, 2009 By: Erik Gruenwedel

Wall Street’s love affair with Netflix is apparently exceeding reality, according to Wedbush Morgan Securities analyst Michael Pachter, who downgraded the online DVD rental pioneer’s stock to “underperform” from “neutral.”

Pachter said Netflix’s Nov. 23 closing share price of $60.38 represented a multiple 27 times projected fiscal-2010 (ending Dec. 31) earnings of $2.15 per share. He believes Netflix’s target share price is more realistically reflected at 22 times projected share earnings.

The Los Angeles-based analyst said that Netflix’s recurring “solid” financial results, streaming initiative with the Sony PlayStation Network and decision to buy back $200 million in company shares couldn’t hide the fact studios are taking a harder stance toward Netflix.

“The studios are seeking higher payments for streaming content, and Netflix’s 10% margin cap appears to … be a concession to the studios,” Pachter wrote in a note. “We do not expect the studios’ thirst for a greater share of revenue to subside, and we expect to see Netflix’s COGS (cost of goods) rise as its ARPU (average revenue per user) declines, leading to lower gross profit.”

The analyst said he expects Netflix in the near future to announce a streaming deal with the Nintendo Wii, which coupled with PS3, would create a much larger potential audience of lower revenue streaming.

“While we expect this to be largely offset by postage savings, we think that earnings growth will be limited by higher [streaming] payments,” Pachter wrote.

Indeed, Netflix co-founder and CEO Reed Hastings, in a recent financial call, said the service would spend $700 million on postage in 2010, up $100 million this year.

Netflix shares fell 71 cents to close Nov. 24 at $59.67 per share.

Separately, a former Spokane, Wash., postal worker is reportedly suing the Postal Service claiming he was fired in 2007 for refusing to accept a late shipment of 20,000 Netflix DVDs.

The postal worker told The Spokesman-Review the truckload of DVD rentals arrived after the processing deadline. The worker, who was subsequently suspended and fired, said he wants his job back, according to the newspaper.

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