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UPDATE: Netflix Cancels Qwikster Launch

10 Oct, 2011 By: Erik Gruenwedel

Sudden reversal keeps disc rental service under Netflix brand and likely kills possible sale of streaming business to Amazon, analyst says

In another twist, Netflix Oct. 10 said it is canceling the planned rollout of by-mail disc rental unit Qwikster and will continue the pioneering service under the Netflix name.

In a post on the Netflix blog, co-founder and CEO Reed Hastings said the controversial decision to separate physical DVD and Blu-ray Disc rentals from streaming would confuse current and new subscribers.

"This means no change: one website, one account, one password … In other words, no Qwikster," Hastings wrote. "While the July price change was necessary, we are now done with price changes."

The latter referred to the much-criticized 60% rate hike imposed Sept. 1 on Netflix's popular combined streaming and disc rental platform — a move that precipitated mass subscriber cancelations and sent Netflix's stock price on a freefall.

Hastings then reiterated the fact Netflix has added 3,500 new TV episiodes to its streaming service in recent days of whirlwind content license agreements with content holders.

"We value our members, and we are committed to making Netflix the best place to get movies and TV shows," Hastings wrote.

While it's difficult not to take Hastings' explanation at face value, it appears there was more at play abandoning Qwikster than simply valuing subscriber sentiment, according to Michael Pachter, analsyt with Wedbush Securities in Los Angeles. Pachter believes Qwikster was scuttled after Amazon pulled back from a deal that would have seen the ecommerce behemoth acquire Netflix's streaming business.

Specifically, Amazon killed the deal after Netflix shares plummeted in value and subscriber attrition was revealed to be greater than forecast. Pachter said Amazon considered acquiring Netflix's streaming business for around $200 a share -- a deal that would have greatly upped its Prime streaming service and given it enahnced access to content. With the streaming and physical disc businesses separate, Amazon could have assumed Netflix streaming without having to contend with Qwikster's physical distribution presence in multiple states and the accompanying sales tax issue.

Netflix in turn would have used the resources from the sale to renew its Starz deal and focus on Qwikster. Indeed, Starz is considered the aggregator to more than 26% of all movie content in the pay-TV window.

"We believe Amazon could no longer justify a purchase price exceeding $200/share given Netflix’s current share price and likely additional customer attrition from the continuing backlash," Pachter wrote in an Oct. 10 note.

The analyst, who changed his rating on Netflix to "neutral" from "outperform," said physical DVD and Blu-ray Disc rentals continjue to play an important part in Netflix's business, with more than 14 million current members still renting discs.

Regardless, Pachter, who expects Netflix to receive some time of multi-million dollar break-up fee from Amazon for killing the deal (and killing Qwikster), said Netflix's continued growth based on $7.99/month streaming or one-disc subscribers is not a profitable scenario given the company's international expansion plans. The analyst also believes Netflix's projected defection of 7 million subscribers from its $15.98 hybrid streaming/disc program is wishful thinking.

"We think that this number is far too low," Pachter wrote. "In our view, this [$15.98] price point is too high for middle and lower income customers, and the new pricing will force a significant number of existing customers to trade down to one of the $7.99 monthly offerings."

The analyst contends Netflix will be hard pressed to generate projected subscriber growth with access to movies primarily from Epix and indie sources after next February when the Starz deal expires.

"Until we see the ending subscriber figures for the September quarter and the company’s breakdown of subscribers by category, it will be difficult to estimate the starting point or pace for future subscriber growth," Pachter wrote.

Netflix reports third-quarter results (ended Sept. 30 ) Oct. 24.

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