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Analyst: Netflix Masking DVD 'Profit Potential' With Streaming

By : Erik Gruenwedel | Posted: 03 Mar 2010

Netflix could unleash even greater profit margins with its by-mail DVD rental business if it cut back on digital streaming expenses, an analyst said.

Eric Wold, with Merriman Curhan Ford in New York, said Netflix could elevate itself as the go-to rental service by non-subscribers (i.e., kiosk, in-store and VOD customers) due to its large catalog (100,000+ titles) of older movies.

Los Gatos, Calif.-based Netflix generates about 70% of revenue from catalog titles, according to company statements. In addition the company said it has reached less than 10.8% household penetration in the United States, which Wold said suggests tremendous opportunity, considering there are 92 million households with a DVD player.

“Not only does Netflix stock a majority of older titles that can easily be searched and accessed (as well as recommended by Netflix’s proprietary algorithms), but it can fulfill consumers’ needs for older movies that do not have to be watched immediately,” Wold wrote in a note.

The analyst said the catalog consumers generate lower churn (less likely to cancel monthly subscriptions) and higher gross margins since older DVD movies have a higher degree of depreciation and are less likely to be part of studio revenue-sharing agreements.

“Even with the advent of additional streaming/VOD services coming into the home, we believe the relatively low price point of DVD rentals will keep the physical DVD segment strong with increasing penetration for at least the next 10 years,” Wold wrote.

Indeed, Netflix increased its projected operating margin to 11% from 10% in 2010, which Wold considers conservative given the service’s 11.5% operating margin in the most recent quarter and the millions it spends affording subscribers with free access to streaming content.

The analyst said efforts by Wal-Mart, Best Buy and TiVo to rollout digital content services, including movie downloads and streaming, revolve around new releases and are complimentary to Netflix’s Watch Instantly service.

“We believe Netflix has the opportunity to throttle back the streaming spend to some degree given the value of the by-mail service, which could unleash tremendous earnings and cash flow power over the coming years (well above current expectations),” Wold wrote.


User comments

Commented by James
Posted on 2010-03-03 10:46:34

Digital delivery will never be mainstream, at least not in the near future, many ISP's have started going after customers who are using large amounts of bandwidth and either banning them on the suspicion of downloading illegal content, capping how much bandwidth can be used and cutting them off when they hit the cap, or charging them outrageous amounts for extra usage.... unless things change (which is highly unlikely anytime in the near future) digital delivery will never take off........ in my opinion it's a waste of funds and resources.

Commented by movieguy
Posted on 2010-03-03 18:07:28

I fully agree with james. Bandwidth caps are going to implemented to preserve net neutrality. Plus, bandwidth is worth its weight in gold since majority of people cant live without email. When the caps hit either price of streaming goes up or isp get stuck with the cost of 3RD Party content providers. Question i have is simple, if digtal is the future at what point do all brick n motor go extinct since you can buy almost everyting on line and have it shipped to your house

Commented by James
Posted on 2010-03-04 14:15:44

Brick and Morter will never go extinct, there are far far to many un-trusting consumers in the world to let it, and until they can build "transporters" that can put the merchandise in the hands of the buyer instantly it's just not going to happen. Traditional rental stores within 10-15 miles of each other are going to cease to exist, big box stores paying $4,000+ per month leases will die in most areas, leaving it wide open for smaller Mom and Pops to come back into play for the rental revenue that is left out there, recently in this area people made a big deal about one of the local Blockbusters that closed down... when I talked to one of the employee's working there she told me that store had lost money for three years... and blamed it on Illegal downloading, I then tried to decipher what could have gone wrong... I usually rule out Netflix and Redbox, while they are both doing well their penetration is still a smaller percentage of the total rental revenue out there, there are many many people who don't wa


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