If you come away from Netflix's (NASDAQ:NFLX) latest quarter with nothing else, it should be this: The DVD rental business has rapidly become commoditized as customers shop by price.
That, at least, appears to be the message Netflix's earnings conference call, on which top execs spent a considerable amount of time from the very start talking about the toll Blockbuster's (BBI) new online offering has taken on its business. Competition from Blockbuster, the company has said, hurt first quarter performance: revenue and net income came in at the low-end of guidance; EPS missed estimates by 2 cents. Furthermore, second quarter revenue and EPS guidance is considerably below expectations; for the full year, the range for revenue guidance was also lowered.
Netflix CEO Reed Hastings said he's confident Blockbuster's low prices aren't "economically viable." He added that it's "not a question if, but when Blockbuster will reset prices."
Perhaps, but customers are no dummies. They obviously like the combination and flexibility of mixing bricks-and-mortar with online. More importantly, they have now proven that if service and selection are similar, they'll go with the company that offers the lowest price, margins be damned.
Here's where it gets tough for Netflix, whose churn last quarter inched up to 4.4% from 3.9% in the fourth quarter: Subscriber acquisition costs continue to rise, hitting $47.46 last quarter compared with $44.31 in the fourth quarter and $38.47 a year ago. There's also the law of large numbers: Growth rates are sliding, with revenues ahead by 36.2%, down from 43.6% last quarter and 47% a year ago. More telling is subscriber growth, which last quarter last quarter rose by 39.7%, compared with 51.1% in the fourth quarter and 61.2% a year go.
Most remarkable is that Netflix now appears firmly to be on the defensive, trying to figure out what Blockbuster will do next and suggesting that Blockbuster is headed for financial ruin. Maybe they'll be right, but it's worth nothing that last year Blockbuster generated $250 million in free cash flow after spending $100 million in interest expense. Hardly the appearance of a company on the verge of a nervous breakdown. (The first quarter, of course, could be a different story.)
P.S.: I've previously needled Netflix for juicing its stock with guidance that net income would grow at 50% "in 2007 and beyond." Based on current guidance, this year's net income is on track to rise 18% from last year. Maybe Netflix, which by all accounts has done a great job building its brand, should pay more attention to managing its business rather than managing Wall Street.
NFLX 1-yr chart: