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UPDATE: Netflix Stock Falls on Sub Price Cut

15 Oct, 2004 By: Stephanie P. Holly W.

Netflix stock fell 41 percent today following yesterday's announcement that it would drop its three-out subscription price to $18 a month, anticipating a cutthroat battle with Amazon.

The stock also plummeted on a Blockbuster announcement that it would drop its online sub price to $17.49 from $19.99, igniting a price war.

Netflix executives expect the Internet behemoth Amazon to get into online DVD rentals late this year or early next year.

In light of these new pressures, Netflix also will postpone plans to expand into Canada and the United Kingdom for at least a year.

“The rumors of Amazon started about two weeks ago, and over the past two weeks we have been confirming them,” CEO Reed Hastings told analysts. “If we had known in Q1 that Amazon was planning to enter this market, we would not have raised our prices from $20 to $22, and we would not have planned a U.K. launch.

Even before the Blockbuster announcement, Hastings anticipated a price war.

“What happens if our competitors match or beat our [new] price? If that happens, the only thing that is a certainty is that the video stores of America will be vacant.”

Blockbuster, Movie Gallery and Hollywood Entertainment Corp. stock fell more than 6 percent, nearly 8 percent and nearly 3 percent, respectively, today.

“Our customers have encouraged us to offer low-priced, online DVD rentals, but we have no announcements to make,” an Amazon spokesperson said.

Hastings called Amazon's potential entry into the marketplace “a bitter and surprising pill for those of you who are long on our stock.”

“One of the reasons we thought they were not going to get in this space is that they hadn't, and they were not prepared to leverage their infrastructure,” Hastings said. “We had thought that if they were going to enter, it would have been in 2002 or 2003.”

Anticipating a pitched battle with the only potential competitor with built-in online reach, Netflix will focus on its U.S. operations, growing its subscriber base to be in a leading position for video-on-demand (VOD) and getting into position to offer VOD by the end of next year.

“We will put our full focus on DVD rental and are prepared to win this critical phase of the market battle,” Hastings said.

The price change takes effect Nov. 1. The three-out plan had been $19.95 for three years when Netflix increased it to $21.99 in June of this year, alarming some analysts.

The new $18 price should bring in “more casual renters” who will keep their subscriptions while renting less, thus helping Netflix build its subscriber base while keeping costs down, Hastings said.

Wal-Mart's three-out price is $18.76.

“We think we are one or two generations ahead in cost efficiency,” Hastings said, so Netflix will “strengthen our competitive differentiators by growing fast.” The goal is to have 4 million subscribers by the end of next year because “a large subscriber base will be the key asset to electronic delivery of movies,” he said.

Nonetheless, the company expects to operate at break-even during 2005 as it makes efforts to “protect and grow long-term shareholder value,” Hastings said.

“If we are able to achieve 20 million Internet DVD subscribers and then can offer them the option of electronic delivery, we will have more reach than any cable or satellite company in America other than Comcast,” he said. “Starting in 2005 we will offer electronic delivery if the studios make available the films.”

In another announcement, CFO Barry McCarthy will remain for another year, although in January he announced his plan to leave the company at the end of the year.

For the quarter ended Sept. 30, Netflix reported revenue of $141.6 million, up 18 percent from $120.3 million in the second quarter. GAAP (generally accepted accounting practices) net income for the third quarter was $18.9 million compared to $2.9 million for the second quarter of 2004. Net income benefited from lower-than-expected usage in the quarter, the change in amortization policy for catalog DVDs and a reduction in salvage value, the company reported.

The company finished the quarter with 2.2 million subscribers, including 590,000 trial subscribers. Churn during the quarter was 5.6 percent, compared to 5.2 percent in the third quarter of last year.

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