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Analyst: Netflix 'Worse Today' Than Two Years Ago

7 Mar, 2013 By: Erik Gruenwedel

Netflix’s financial outlook is worse today than it was in 2011 — the year CEO Reed Hastings lost $12 billion in market capitalization implementing a 60% price hike to its most popular rental plan and ill-fated spin-off of its pioneering by-mail disc business, an analyst said.

Speaking March 6 on CNBC’s “Fast Money,” Michael Pachter, analyst with Wedbush Securities in Los Angeles, reiterated a long-standing belief that Netflix’s business fundamentals are flawed. Principally, Pachter said the subscription video-on-demand pioneer is over-leveraged in streaming content license agreements with studios and media companies while spending tens of millions every quarter expanding operations internationally.

Netflix has more than $5 billion in third-party content license agreements, including $2 billion payable this year.

“This is a worse company today than it was a couple of years ago,” Pachter said. “They have destroyed their DVD business, which is the source of three-quarters of their operating profit. They are chasing windmills overseas and the content owners are never going to let them make money there.”

Netflix’s domestic streaming segment added 10 million subscribers in 2012 and generated $109 million in operating profit in the fourth quarter (ended Dec. 31). However, most of that was negated by a $105 million operating loss in foreign operations. Netflix’s by-mail unit generated $128 million in operating profit, despite management’s ongoing efforts to marginalize its relevance.

Indeed, when Netflix shipped its 4 billionth DVD rental in January, the company made little notice of the milestone. Hastings ignored it during the company’s Jan. 23 fiscal call with analysts. Instead, representatives from Netflix’s regional disc shipping hub and the U.S. Postal Service honored the subscriber locally in Illinois.

Pachter, who is a long-time contributor to Home Media Magazine, agrees Netflix’s domestic SVOD sub growth has been good, but argues investors and Wall Street lavish too much praise on one specific metric. He said investors currently value Netflix at $400 per subscriber while barely making money. The analyst contends Netflix should raise rates $8 to $16 monthly — a move Pachter said would only lose 25% of subscribers in the short term.

“They're valued [now] like they're going to make $30 per domestic sub, and they make about $2.50, so they have a long way to go before you can justify this valuation,” Pachter said. “I don't see it going higher.”

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