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Analyst Rains on Netflix’s Parade

24 Jul, 2009 By: Erik Gruenwedel

Less than 24 hours after Netflix posted record quarterly earnings and the addition of 289,000 subscribers, Oppenheimer & Co. analyst Jason Helfstein July 24 downgraded the online DVD rental pioneer’s stock from “perform” to “underperform,” claiming investors don’t understand the long-term risks to the perennial Wall Street darling.

Specifically, Helfstein said investors aren’t taking into account the rapidly evolving entertainment food chain in which traditional movie DVD rentals and sellthrough are being supplanted by alternative distribution models, including streaming and kiosks.

He said studios will pose major challenges to Netflix as it transitions to streaming and studios start to embrace higher growth alternative distribution models such as the recently announced deal between kiosk operator Redbox and Sony Pictures Home Entertainment.

The analyst also cited economically favorable (higher margin) models to DVD, including pay-per-view, digital downloading and Blu-ray, which he said would hurt Netflix’s fixed-price subscription deals.

In addition, Helfstein said Netflix’s stated desire to significantly upgrade its electronic content (from 12,000 titles) would negatively affect operating margins due to increased license fees. Also, movie DVD sellthrough through the mid-year fell more than 13%.

“Studios are seeking to increase revenue by expanding distribution and better aligning their economics with emerging industry trends,” Helfstein said in a note. “Ultimately, we believe Netflix will be relegated to more profitable long-tail content but with limited consumer demand.”

The analyst said Disney CEO Bob Iger’s recent decision to explore distribution of content via micro-SD chips underscores the probability of that kiosk-based USB downloads may soon emerge.

“All of this broadens and cheapens consumer access to content,” Helfstein said.

Netflix, per policy, does not comment on analyst comments or market valuations.

The Los Gatos, Calif.-based service’s stock declined more than 9.5% ($4.51) to $42 per share in late trading July 24.



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