Rick Hanley

Netflix's Problems Keep Biting It In the Worst Way

Subscriber Additions
With a seasonal business, you must look at like quarters.
The SAC for 1st Qtr, 2006 = $77 per each net addition of a total of 687,000 net subs added.
The SAC for 1st Qtr, 2007 = $150 per each net addition of a total of 471,000 net subs added.
The 2nd Quarter in 2005 and 2006 were very weak with net additions of 178,000 and 303,000, respectively. For whatever reason, the 2nd Quarter is dramatically lower than the other quarters of the year.
This, plus competition, seems to be what points to the prediction by Netflix of close to zero net sub growth in 2nd Qtr 2007. They will need to get 800,000 to 1,000,000 new gross subscribers in the 2nd Qtr, 2007 to replace the 800,000 to 1,000,000 that will quit the service in the 2nd Qtr, 2007 (the quit rate exceeded 800,000 in both the 3rd and 4th Qtr of 2006).
The subscription model requires ever increasing expenses to grow. This is normal and it is a given. A quandary arises when no amount of expense will any longer increase growth.

Netflix's Problems Keep Biting It In the Worst Way

Correction:

Was:
The range is from negative 100 million to positive 100 million in the net sub change for the 2nd quarter.

S/B:
The range is from negative 100 thousand to positive 100 thousand in the net sub change for the 2nd quarter.

Netflix's Problems Keep Biting It In the Worst Way

Netflix – 1st Quarter, 2007 Results and Conference Call
From call: Q2 guidance for subscribers is possibly flat at 6.7 to 6.9 million subscribers.
The range is from negative 100 million to positive 100 million in the net sub change for the 2nd quarter.
A growth company can’t have 0 growth. That will upset some people. Aligned with this thought is that Reed should have dropped the 20,000,000 subscriber projection for 2010 - 2012 a long time ago. It was dishonest before and now it is a joke.
The company is 40% owned by management and Legg Mason so 40% of the announced $100,000,000 buyback benefits them. Good or bad for everyone else? I don’t know. No better use for the cash? – very interesting. [I suppose that, technically, the whole $100,000,000 could go to insiders? Hoag/TCV owns over $200,000,000 of the stock.]
Blockbuster isn’t even close to being the whole competitive problem that Netflix has.
At some point last year, Netflix had 20% of fulfillment due to TV series. The broadcasters are taking Internet distribution of TV shows back in house and Apple and others are now doing a huge volume with TV shows (many times more than the unit count for movies; for one thing, they are cheap and easy to do by download).
Many people are now in the business of distributing catalog films. At one time, Netflix virtually had it to themselves. This dynamic, in particular, has really taken off over the last several months.
Profitability attracts competition. Reed has been a skilled marketer but sometimes attention brings problems.
From Tech Trader (WSJ): !!!
...A scarier number - which you have to calculate - is the soaring cost of net subscriber additions: each net new subscriber cost the company $150 in the latest quarter, up from $101 in the fourth quarter and $77 in the year-ago quarter...
[Um, maybe expenses are not heading down as the analyst from Lehman Brothers (Doug Anmuth) said. Unless there is some possible way to pay the workers in the distribution centers less money. Actually, the vast majority of Netflix workers are in the distribution centers and they must handle, physically, every DVD that comes and goes. No scaling possible. Advertising can only grow as it gets progressively harder to get the next subscriber.]

Hastings Addition To Microsoft's Board A Smart Move For Redmond

To buy Netflix, what would it cost Microsoft? With the current market cap at $1.6 billion, would the price be $2 billion? Is that a payback of 10 years? 20 years?

Does Microsoft want 1,500 new employees from Netflix? Remember that there is no material ability to reduce the 1,200 employees that work in the distribution centers. The core work in a physical DVD rental by mail model requires that envelops must be manually opened, discs physically handled/inspected, and then discs stuffed manually into envelops.

Separately, can Reed Hastings offer truly unbiased opinions to Microsoft while still working at Netflix? Won't there be some conflicts as he offers input on the global view of things to the board and top managers at Microsoft?

Hastings will leave Netflix while he is at the top and dedicate himself to new opportunies.

Netflix: Overwhelming Number of Competitors Makes For a Difficult Buy

Dennie - So Netflix made Wal-Mart shiver in their boots? Please. Have you noticed that no one has bought Netflix?

Anyway, the competition for consumer cash and eyeballs grows ever larger. Will Netflix survive what is happenning in the market? Comcast, in partnership with C-COR, is bringing to the thousands of very small cable companies the capability to offer VOD. The millions of customers of these small cable companies have been one of the sweet spots for Netflix and the other online DVD rentailers.

In June, Wal-Mart will begin to offer, for purchase by mail order, 60,000 catalog titles, obviously covering much of the catalog films in existence. Catalog films are the bread and butter for the Netflix business model. Imagine the price points that someone like Wal-Mart can offer in this space.

Game console sales are exploding and they provide a double whammy on Netflix during this round. Not only is the number of gamers growing dramatically, the consoles allow downloding of movies, TV shows, etc.

Remember, there is a limited amount amount of time and cash to go around. Netflix's own projections are fro decidedly slower growth.

New Movie Download Ventures Threaten Netflix

Cleared for Takeoff

Imagine 'in-store download and burn kiosks' in Wal-Mart, Target, Best Buy, and/or Walgreens? Extremely cost effective availability of tens of thousands of titles. The content owners, retailers, and consumers all win. And the environment, too. No more online, physical DVD rental models that involve millions of physical deliveries each week.



What had been the key differentiator for Netflix, catalog films, will now be widely available to retailers. Clearly, we all want to see the day when in-home download is as easy as using the TV is today. That is coming, too.



Video Business Online

Download-and-burn cleared for takeoff
Movielink plans summer test with new CSS-enabled discs
By Paul Sweeting -- Video Business, 2/8/2007
FEB. 8 | The DVD industry has cleared the way for retailers and consumers to burn movie downloads to DVD for set-top playback.

The steering committee of the DVD Forum on Jan. 31 formally approved technical specifications for a new type of recordable disc for use with in-home and in-store burning of CSS-protected movies, removing the last remaining administrative hurdle to commercial deployment of download-and-burn services…



Online download services have been waiting for the approval to give consumers the option of burning movies they can now only play on their PC or portable device.

Studio-owned download service Movielink plans to begin testing burn-to-DVD downloads this summer and offer it to all consumers by the fall, chief marketing officer Mary Coller Albert said…



Wal-Mart also is said to be considering adding download-to-burn for its just-launched service.

“We expect that to improve over the course of the year, and we’ll continue to aggressively explore/evaluate opportunities and models for this option over the next year,” Wal-Mart said in an e-mailed statement…



With the final specs approved, disc makers can now begin manufacturing DVD Download blanks for sale to consumers and in bulk for enterprise applications such as in-store burning kiosks.

The discs are similar to standard DVD-R’s but are “pre-keyed” with CSS decryption codes so they can accept encrypted data.

The use of CSS—the same copy-protection system used on commercially pressed discs—is considered critical to ensuring that discs burned from downloaded movie files will be compatible with all set-top DVD players…



Initially, download-and-burn may be a bigger opportunity for bricks-and-mortar retailers that bring in DVD burning kiosks rather than for online download companies…



“In theory, it can be a very nice revenue generator [for retailers] without having to give up any kind of significant footprint,” Goodman said.



© 2007, Reed Business Information, a division of Reed Elsevier Inc. All Rights Reserved.

www.videobusiness.com/...

Rick

Movie Download Wars: Wal Mart Grasping at Straws

Cleared for Takeoff
Imagine in-store download and burn to DVD kiosks at Wal-Mart, Target, Best Buy, and/or Walgreens? Extremely cost effective availability of tens of thousands of titles. The content owners, retailers, and consumers all win. And the environment, too. No more online, physical DVD rental models that involve millions of physical deliveries each week.

What had been the key differentiator for Netflix, catalog films, will now be widely available to retailers. Clearly, we all want to see the day when in-home download is as easy as using the TV is today. That will come.




Video Business Online
DOWNLOAD-AND-BURN CLEARED FOR TAKEOFF
Movielink plans summer test with new CSS-enabled discs
By Paul Sweeting -- Video Business, 2/8/2007
FEB. 8 | The DVD industry has cleared the way for retailers and consumers to burn movie downloads to DVD for set-top playback.
The steering committee of the DVD Forum on Jan. 31 formally approved technical specifications for a new type of recordable disc for use with in-home and in-store burning of CSS-protected movies, removing the last remaining administrative hurdle to commercial deployment of download-and-burn services…

Online download services have been waiting for the approval to give consumers the option of burning movies they can now only play on their PC or portable device.
Studio-owned download service Movielink plans to begin testing burn-to-DVD downloads this summer and offer it to all consumers by the fall, chief marketing officer Mary Coller Albert said…

Wal-Mart also is said to be considering adding download-to-burn for its just-launched service.
“We expect that to improve over the course of the year, and we’ll continue to aggressively explore/evaluate opportunities and models for this option over the next year,” Wal-Mart said in an e-mailed statement…

With the final specs approved, disc makers can now begin manufacturing DVD Download blanks for sale to consumers and in bulk for enterprise applications such as in-store burning kiosks.
The discs are similar to standard DVD-R’s but are “pre-keyed” with CSS decryption codes so they can accept encrypted data.
The use of CSS—the same copy-protection system used on commercially pressed discs—is considered critical to ensuring that discs burned from downloaded movie files will be compatible with all set-top DVD players…

Initially, download-and-burn may be a bigger opportunity for bricks-and-mortar retailers that bring in DVD burning kiosks rather than for online download companies…

“In theory, it can be a very nice revenue generator [for retailers] without having to give up any kind of significant footprint,” Goodman said.

© 2007, Reed Business Information, a division of Reed Elsevier Inc. All Rights Reserved.
www.videobusiness.com/...

Movie Download Wars: Wal Mart Grasping at Straws

Rentals are more likely to be a mechanism for cannibalizing DVD sales revenue. A download for $20 is worth more that a physical DVD sale for $20. Much less overhead on the download.

When considering the whole impact of Wal-Mart, consider this: Wal-Mart also announced, but received rare coverage of, the availability of 60,000 titles for sale by mid-year. With Wal-Mart's pricing power, guess what that means to Netflix, Blockbuster, etc.

Red Herring
The Business of Technology
Wal-Mart Intros Movie Downloads
…Wal-Mart will use the foray into digital movies as a way to build a full-service online store aimed at home entertainment.

“We view this as the first step to move toward a multi-format and multi-channel strategy,” said Cameron Janes, director of digital media for Wal-Mart. “We are looking at leveraging the digital platform to support manufacturing on demand and offer a range of movie titles.” Those include independent films, foreign films, as well as hard-to-find titles.

Willem de Zoete, head of HP’s digital entertainment services business, said the company is building a business based on custom DVD distribution.

About 60,000 DVD titles will also become available through a mail-order service in which consumers have an option to go online and order the discs. The service will launch mid-year.

© 1993-2006 Red Herring, Inc. All rights reserved.
www.redherring.com/Art...;hed=Wal-Mart+Intros+M...

Blockbuster Hits 2 Million Online Subs - At Netflix's Expense?

Doesn't quite fit but it says to me that it would be a miracle if Netflix added 500,000.

Quarterly Subscriber Additions
Total Subscribers q/q change Gross Additions q/q change Quit Netflix Net Additions
4th Qtr 2004 2,610 783 402 381
1st Qtr 2005 3,018 15.63% 945 20.69% 537 408
2nd Qtr 2005 3,196 5.90% 707 -25.19% 529 178
3rd Qtr 2005 3,592 12.39% 921 30.27% 525 396
4th Qtr 2005 4,179 16.34% 1,156 25.52% 569 587
1st Qtr 2006 4,866 16.44% 1,377 19.12% 690 687
2nd Qtr 2006 5,169 6.23% 1,070 -22.29% 767 303
3rd Qtr 2006 5,662 9.54% 1,310 22.43% 817 493

Netflix Faces These Six Challenges

A macro discussion of the space in which Netflix operates partially using information from Citigroup/comScore:

Citigroup
Internet Matters: December 2006
December 14, 2006

In terms of U.S. Internet users, the number of U.S. Internet unique visitors reached a record high 174MM in November. For context, we note that the 2.3% Y/Y U.S. growth rate for October and November was the lowest ever recorded by comScore. This marks a continuation of the steady deceleration through single-digit growth land that comScore has tracked for U.S. Internet users. A reflection both of the large numbers law as well as market maturation.

U.S. Apr-06 May-06 Jun-06 Jul-06 Aug-06 Sep-06 Oct-06 Nov-06
Y/Y 4.10% 4.00% 3.80% 3.40% 2.90% 2.50% 2.30% 2.30%
M/M 0.20% 0.30% 0.50% 0.20% 0.10% 0.00% -0.10% 0.20%

Multi-channel retailers such as Wal-Mart and Target are experiencing more robust Y/Y growth rates. In November, Wal-Mart and Target visitors grew 23% and 22%, respectively. Partly, this is the law of small numbers. But the market share risk to eBay and Amazon from multi-channel retailers remains intact. We also note that in the month of November, 10 out of the top 20 retailers online were multi-channel retailers.


RICK HANLEY OBSERVATIONS
Remember the old joke about Amazon putting Barnes & Noble out of business? Just because Netflix opened a store on the internet does not mean that they own DVD distribution.

Broadband penetration does not affect the Netflix DVD-by-mail model. Anyone who wants to use the service has always been able to do so with whatever connection that they have.

My summary is that the best days are behind Netflix. There are virtually no U.S. citizens/internet users that have not heard of Netflix. Who is not sick of seeing Netflix ads? As of 9/30/06, about 11,000,000 people have tried Netflix and about 5,650,000 remain as subscribers. Let’s guess that the easy fish have been caught.

For years, Netflix has been projecting 20,000,000 users. No matter what changes occur in the environment that they operate in, they don’t change their projection.

o VOD is booming
o DVD kiosks are booming
o Download is growing (without Netflix so far, if you can believe it)
o Competition for eyeballs from gaming is booming
o Blockbuster and Movie Gallery are not going away
o Blockbuster is growing their online subscribers
o Some studios have announced that they will open download stores (they own the content)

Netflix Faces These Six Challenges

Another indication that the studios and cables will directly own delivery of content. Think disintermediation, financial might and scale.

Multichannel Newswire
Time Warner Expands VOD Offering
By Mike Reynolds 12/15/2006 12:02:00 AM
Time Warner Cable’s system serving the Greensboro, N.C., market is expected to raise the curtain Friday on a robust on-demand platform that figures to encompass close to 2,000 titles by mid-2007.
Working with In Demand Networks, the system plans to introduce More Movies on Demand, a virtual video store, to its customer base with an eye toward lighting up a number of other divisions throughout 2007.
Whereas current releases cost $3.95 per film, most of the additional titles will be priced at $1.95, with special themed movies going for 99 cents, as a means to stimulate impulse sales.
During the first quarter, he anticipates that other Time Warner divisions will roll out the expanded movies offerings..
Asch said In Demand was garnering the additional titles from such studios as Universal Studios, Paramount Pictures, 20th Century Fox, Metro-Goldwyn-Mayer, Lionsgate and Warner Bros. “And we’re in conversations with everybody else,” he added.
www.multichannel.com/a...

Netflix Faces These Six Challenges

Download is an entirely different space than DVD by mail and Netflix does not have a prayer.
Important developments:
DVD BURNING SET FOR ROLLOUT
DVD Forum approves new recordable disc with CSS copy-protection
By Paul Sweeting — Video Business, 12/7/2006
Industry efforts to develop a uniformly compatible download-and-burn system have cleared the last major technical hurdle, opening the way for commercial implementations of customer burning services early in 2007.
FREEMAN’S CLICKSTAR SIGNS MAJOR STUDIOS
Sony, Universal, Warner add films to new movie download service
By Jennifer Netherby — Video Business, 12/11/2006
The three deals announced today will make movies from the studios available on ClickStar the day they debut on DVD as a download-to-own copy or rental.
For the rest of the story:
www.videobusiness.com/...
DISNEY/COMCAST DEAL DESCRIBED IN THE PRESS
Comcast also secured on-demand access to such hit ABC shows as Desperate Housewives and movies from Disney’s film studios, such as Pirates of the Caribbean 2, for its customers.
Those movies could become available to Comcast customers as soon as 15 days after they are released on DVD. That’s about 15 fewer days than in current windows.
TIME WARNER AND FOX have stated that they will launch their own download sites - this is a perfect case of disintermediation. Why give middlemen a cut?
Comment by Rick Hanley - December 14, 2006 at 11:02 am
ANOTHER REASON FOR PRESSURE ON NETFLIX SHARE PRICE
Netflix board members include people who trade large blocks of Netflix stock.
Jay Hoag and his VC company, Technology Crossover Ventures (TCV), acquired 12.1 million shares of Netflix this past summer. That’s almost 18% of shares outstanding at 9/30/06. Partners of TCV are on the Board at Netflix, including Jay Hoag.
At the moment, with Netflix at about $29.00/share, Hoag/TCV is sitting on a paper profit of over $250,000,000. What are they likely to do? Sit on it and possibly watch it fade away? Twice before, they sold significant shares in the late January timeframe (in 2004 and in 2006).
Hoag/TCV had invested in Netflix early and helped Hastings take Netflix public and Hoag/TCV received shares and/or options and/or warrants for their investment in Netflix. Hoag/TCV took some part of their gains off the table in 2004 and 2006.
• Hoag/TCV sold 1,498,600 shares (pre-split) on 1/26/04 for $113,219,230.
• Hoag/TCV sold 2,000,000 shares on 1/27/06 for $54,560,000.
Anyway, this past summer Hoag/TCV decided to re-up their investment in Netflix. They acquired 8.3 million shares through the exercise of warrants (kind of like options) at a cost of $1.50/share. Then they bought 3.8 million shares in the open market at an average cost of about $19.50/share. The cost basis of the 12.1 million shares is therefore about $7.21/share.
My guess is that, one way or another, they will sell a good portion of those shares within 3 to 6 months.
Perhaps a crazy thought: Reed Hastings has about a 5% interest remaining in Netflix. Does he stay around? Last I heard, his family was moving to France.