Shares of Netflix (NFLX) fell more than 15% in after hours trading as the internet streaming company reported its first quarter results. The world's largest video-subscription company warned that subscriber growth will slow down in the second quarter, triggering a sell-off.
First Quarter Results
Netflix reported a $5 million loss for the first quarter of 2012, or $0.08 per share. This compares to a profit of $60 million or $1.11 per share in the first quarter of 2011 and $0.64 for the final quarter of 2011. The $0.08 quarterly loss came in much better than analysts consensus who expected the company to lose $0.27 per share.
Revenues increased 21% year-on-year to $870 million, down 1% compared to the $876 million reported for the final quarter of 2011. Profitability remained subdued as the company increased its (international) marketing efforts, boosting the budget 19% on the year.
Domestic Streaming
Netflix added 1.74 million net subscribers during the first quarter ending up with a total subscriber base of 23.4 million. The number of paid subscribers increased to 22.0 million generating $507 million in revenue. The domestic streaming business, which generates the majority of revenues, reported contribution profits of $67 million for a contribution margin of 13.2%
International Streaming
The international division added 1.21 million in new subscribers to end up with 3.07 million subscribers in total. The company had 2.41 million paying customers, generating $43 million in revenue. The division lost an incredible $103 million in contribution losses as entry costs and high marketing costs heavily effect the bottom line.
Domestic DVD
The domestic DVD business continued to bleed customers. In the first quarter of 2011 the division lost 1.08 million subscribers, vs. a loss of 2.76 million in the final quarter of 2011. The total subscriber base fell to 10.09 million generating $320 million in revenues. The division remains the cash cow of the company generating $146 million in contribution profits as it reported margins of 45.6%
Outlook
For the second quarter of 2012 the company now expects to increase its domestic streaming customer base to 23.6-24.2 million, an increase of 500,000 at the midpoint range vs. net subscriber growth of 1.7 million during the first quarter.
The international customer base is expected to expand to 3.45-4.0 million, an increase of roughly 600,000 new customers vs. net additions of 1.21 million during the first quarter.
The company expects to end the second quarter with 8.95-9.35 million subscribers for the domestic DVD business, a 950,000 decline vs. a loss of 1.08 million subscribers during the first quarter.
For the company as a whole, revenues are expected to come in at $873-$895 million. The company expects to report a bottom line figure between a $6 million loss and $8 million profit.
Valuation
The company ended the first quarter with $804 million in cash, equivalents and short term investments. The company operates with $400 million in long term debt for a net cash position of $404 million. Factoring in a 15% decline in after hours trading the market values the company at $4.8 billion or $4.4 billion for the operating assets. This values the firm at 1.4 times annual revenues and 20 times 2011's annual earnings.
While the company is most likely able to expand revenues for the full year of 2012, profitability remains subdued as increased (international) marketing efforts and a decline in the DVD division continue to impact profitability. Another worry is the increase in the valuation of the content library which represents $1.15 billion in value according to the latest balance sheet.
Investment Thesis
Investors are dumping their shares in after hours trading as the company guided for lower net subscriber addition growth for the second quarter. In the first quarter the company gained 2.95 million streaming customers and lost 1.08 million DVD subscribers, for a net addition of 1.87 million in its customer base. For the second quarter Netflix expects almost a standstill with "merely" 1.1 million growth in streaming customers and a loss of 950,000 customers at the DVD unit, for a mere customer growth of 150,000.
The decline in after hours trading to $85 marks the first time shares have fallen below the $100 mark since January this year. Increased competitive efforts from Comcast's Streampix (CMCSA), Verizon Communication (VZ) and Coinstar (CSTR) start to worry investors.
Furthermore investors are worried about the financing of the $3.9 billion expenditure plan to increase the quality of its content. Analysts also disagree with the method of capitalizing these expenses as assets on the balance sheet and suggest these investment should be treated as expenses.
Today's sell-off is warranted as a cautious second quarter user growth outlook implies competitive pressures are on the rise and financing for the medium term content upgrade is not yet in place, causing fears about dilution in the medium term.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
