Netflix's Postal Woes? Don't Go Postal

Blockbuster (BBI) hasn’t been able to derail Netflix (NFLX) but could the U.S. Post Office? That was a question that popped up earlier this week after results of a November audit by the Postal Inspector General began to circulate in the wider press, and more narrowly from a blog posting on Wired that sounded an alarm but left out important details. The details tell a different story. Fear not.

The audit report in question was from early November (See PDF link Below). It was focused on First Class Permit Reply Mail, the category of mail used by popular movie rental services as well as Game Fly and some audiobook services.

The report found some of the envelopes used in these services were problematic and costly. It noted: “employees manually process 70 percent of the approved First-Class two-way DVD return mailpieces from one DVD rental company because these pieces sustain damage, jam equipment and cause missorts.”

The cost of this manual sorting was estimated to be $41.9m for the past two years, and will be about $61m over the next two.

Netflix wasn’t specifically named but the inference was there to suggest their envelopes were the primary culprit (although other DVD mailers were also suspect in some parts of the report).

The Wired article reported the “Netflix envelopes have become such a headache, the OIG recommends the USPS add a surcharge of 17c on DVD return mailers.” Popular blog ReadWriteWeb, of which I am generally a fan, also reported similarly. Both were misleading and arguably, inaccurate.

The OIG’s audit report did include the possibility of a surcharge, but that prospect followed two other recommendations that were not noted in those articles. The first was that postal management identify the specific characteristics making these envelopes “non-machineable.” The second was that they “notify affected mailers” and have Postal Engineering test any new style envelopes. The presumption in the actual report is that only envelopes still requiring manual sorting after the first two steps had been followed would be charged for manual labor services.

There’s a big gap between the actual report and the blog postings. Figuring out the problem, having a chance to fix it and being fined only if you don’t is not the same as inferring the fine could be imminent right now.

Also, as significant, the audit report was a recommendation to Postal Management not a statement of policy. In fact, the report even noted Postal “Management was not responsive to the findings and recommendations.”

Both the Wired and Read Write Web reports cite Citi analysts on the impact of the 17c surcharge. The analysts use it as grounds to support a sell rating on the Netflix stock and a buy rating on Blockbuster (according to the two articles).

In their math, the analysts point out that 17c an envelope could heavily impact operating income and force Netflix to either pass along the fees to customers (price hike) or cause a significant reduction in operating income per subscriber. The estimate was a greater than 60% degradation. On this subject, they issued a note to their clients writing, as quoted in both articles, a price hike “would exacerbate the risks we see in Netflix’s business model.”

With around 1.6m DVDs shipped per day, it’s true a surcharge would be incredibly costly. If hit with these fees, it could be catastrophic for the stock. Then again, if every content licensor in agreement with Apple (AAPL) pulled out of iTunes tomorrow, Apple’s stock would suffer badly too. That doesn’t mean either sequence of events is in any way likely.

The problem with the analysis and with both postings is the same thing – there is no surcharge currently planned. Though one could happen, nothing indicates it’s in the works or on its way. The post office has noted a potential problem with Netflix envelopes, a floppy leading edge, they’ve also indicated they’d like to see it corrected but there is no policy or plan in place to fix it or seek “manual processing” surcharges.

Netflix has changed their envelopes dozens of times since first launching. The current envelope has been in use for two years and now it may get a review and upgrade. If it happens, that could come with some costs but so high to have a measurable impact on performance? Not likely.

Like Netflix or hate them for the nature of their business. Be bearish, bullish or neutral. Whatever the vantage point, it doesn’t seem likely surcharges are going to be a problem.

As for Blockbuster and calling them a buy? That’s a whole different thermos of Kool Aid. They lost $35m last quarter. They lost plenty over the past years. Maybe they’re turning it around, but I’m not ready to drink that mix. If anything, Blockbuster recent actions have me running the other way.

Disclosure: Author doesn't own any of the stocks mentioned in this article.

Comments

[BorisB]

those lowest rated Citi Group net- number crunchers have skrewed up so many times its a wonder anyone takes their crap seriously. One thing those turkeys didnt mention is that Netflix is making more then $400 million year in pretax gross profits despite price cuts. Too blind to see the numbers on the income statement. over paid idiots.

[BorisB]

Also regarding has Comcast hit bottom? Comcast would like to charge $100 a month and hike that 10% a year, while Netflix is charging $17 a month for unlimited disc plus 17 hours worth of a rapdily improving on demand feature. Then again Netflix is friendly with Microsoft and Cisco Systems. surprise surprise!

[Ceviche Fund Partners LP/Dan Jacome]

I'd be a seller of NFLX -- 8 funds dumped the stock in the last reported period + the sales line has grown at a decelerating rate: our models suggest a big earnings miss is on the way for NFLX

BBI is too toxic for our liking, and we have avoided the stock after looking at their leases

[BruceRN,JD]

I am no economic whiz. I have no business degree either. But the comment by Daniel is amazing to me. Americans live for convenience. Anyone want to argue with that? And, Americans love instant gratification...any arguers yet? I tried Netflix "free trial" two nights ago...and was sold immediately (and I am very tight w/ money). It took five minutes to sign up online, and I was watching a great movie on my computer within six. Then I watched a another "on demand" program, as I continued to eat my pizza that was also delivered to my house on that very cold night. The entire time I sat there I was thinking " where has this been all my life...this is incredible!! Oh hell yeah, I'm going to continue with my membership after this trial thing is over. And I'm gonna tell Blockbuster it can stick that membership". (This is my last month with them now)
That was all after only 10 minutes of signing up with Netflix...and I haven't even gotten a dvd in the mail yet. What do you think will happen when there is some big blow up in the Middle East, gas goes to $6-8/gallon (wait and see), and all of a sudden the average person factors driving cost into going to BB to exchange his movie? With movies on demand and very reasonably priced, and the mail bringing dvds to folks, and gas costs a fortune....regular, average Americans will choose Netflix. Buy it.