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Netflix Investor Letter Q4 2011

If you look closely at Netflix’s (NFLX) fourth quarter earnings, it will become clear why the company wanted to split its DVD and streaming businesses. This is the first quarter that the company is splitting out each business and reporting revenues, profits and margins separately.

While the streaming business is growing (adding 220 subscribers domestically in the quarter), and the DVD business sis shrinking (it lost 2.76 million subscribers domestically), its margins are much worse than the legacy DVD business. The streaming business has an 11% profit margin, compared to a very healthy 52% margin for the DVD business.

Out of Netflix’s total $847 million in revenues last quarter, $476 million came from streaming and $370 million came from DVD rentals (the remainder came from international). The streaming business also has twice as many subscribers: 21.7 million versus 11.2 million. But the DVD business contributed the vast majority of Netflix’s profit: $194 million versus $52 million.

If you break that down, each streaming subscriber is worth only $2.40 in profit each quarter to Netflix, compared to $17.32 for each DVD subscriber. The old business was very lucrative. The new business kind of sucks. The economics are very different. The DVD business had fixed costs, while Netflix is forced to negotiate streaming licenses on a case by case basis with each media company.

Investors are going to have to figure out how long the old DVD business can keep generating cash until the new streaming business takes off, but the stock will be valued based on those future cash flows from streaming. And those future cash flows are worth a lot less than the cash flows from the DVD business. At least that is what it looks like right now.

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Source: Netflix Streaming Margins Are 11%, DVD Margins 52%