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More Analysts Question Netflix Regarding Kiosks

27 Jul, 2009 By: Erik Gruenwedel

Perennial Wall Street darling Netflix received another chink in the armor when an analyst questioned the online DVD rental pioneer’s ability to stave off increased competition from rental kiosks, including market leader Redbox.

Pali Capital analyst Stacey Widlitz, an ardent Netflix supporter (“Once again … an outstanding quarter”), nonetheless wondered if the DVD rental service would be able to keep subscriber acquisition costs (SAC) down, in addition to maintaining a low churn, the percentage of subscribers who do not renew their monthly memberships.

Netflix ended the most recent quarter with a record low SAC of $23.88, which beat Widlitz’s projection by an impressive $2.37 per new subscriber. Churn, however, increased to 4.5% from a three-quarter steady 4.2%.

“We fear that pressure from Redbox [and its much ballyhooed studio deals] could eventually pressure SAC,” Widlitz, said in a research note. “We fear that this [increased] churn percentage is a sign that kiosks are a real competitive headway for the company.”

The analyst said competition from Redbox and other kiosks such as Blockbuster Express and The New Release (soon to be branded Blockbuster Express) would directly target Netflix’s higher margin infrequent rental subscribers.

“This could eventually affect gross margins, in addition to market share,” Widlitz said. “We must also note that an increasing portion of Netflix subscriber growth is coming on the lower-end plans — exactly the customers to which we believe Redbox is the biggest threat.”

She also said Netflix’s continued reinvestment of earnings (profits) in its Watch Instantly streaming service (“For better or worse”) would cap stock valuations at current levels.

Separately, Eric Handler, analyst with MKM Partners in Washington, D.C., said he is intrigued how Redbox will be able to guarantee Sony’s $92 million per year on movies representing just 20% of its kiosk inventory and targeted toward infrequent low-end rental customers.

“[Redbox parent] Coinstar has about $60 million in available cash and generated less than $30 million in free cash flow [in the most recent period], so I imagine there is going to need to be some type of debt deal to cover the costs of this deal, especially since it seems Coinstar has a relatively big capex [capital expenditure] per year,” Handler said.
The analyst said Blockbuster’s nascent Express kiosk initiative through partner NCR Corp. doesn’t have to emulate Redbox’s spending as much as it has to nail down high foot traffic locations.

“RedBox has … first mover advantage in a number of high traffic stores where people show up multiple times per week,” Handler said.

Michael Pachter, analyst with Wedbush Morgan Securities in Los Angeles, July 24 lowered Netflix’s stock rating to “neutral” from “outperform,” citing downward revised fiscal 2009 revenue guidance to $1.67 billion from $1.69 billion.

Pachter said Netflix’s higher margin monthly subscriber base could erode as new members opt for less-expensive plans in order to stream content.

“We believe that a large percentage of Xbox Live Gold members utilize the streaming service in this manner, and we think that the bulk of new Netflix customers joining from Xbox Live are likely at the less expensive $8.99 price point,” Pachter said in a note.

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