Netflix Falls as Forecast Trails Estimates

Netflix Inc. (NFLX) shares fell the most in more than two months amid investor concern that an accelerated international expansion may hurt profitability.

This quarter, Netflix forecast profit of 89 cents a share, according to a statement yesterday, short of the $1.02 projected by analysts. The stock slipped 4.6 percent to $431.09 at the close in New York, the biggest decline since May 6.

The forecast reflects international expansion costs, Chief Executive Officer Reed Hastings said. Netflix, based in Los Gatos, California, is spending to back production of Harvey Weinstein’s “Marco Polo” series in Kazakhstan and Malaysia, market its service in Mexico and acquire rights to expand to Germany, France and four other European countries in September. Hastings has made clear he’s willing to sacrifice profitability to extend his lead in online television.

“We hope it’s similar to our success in the past, where there are significant upfront losses that abate over the coming years,” Hastings said yesterday in a telephone interview. “Our long-term guidance is to run the company at breakeven as we’re engaging in this international expansion.”

Expansion Costs

Netflix sees a $42 million third-quarter loss outside the U.S., almost triple the $15 million loss in the period just ended, according to its quarterly letter to investors.

Photographer: Andrew Harrer/Bloomberg

The Netflix hit series “Orange Is the New Black.” Close

The Netflix hit series “Orange Is the New Black.”

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Photographer: Andrew Harrer/Bloomberg

The Netflix hit series “Orange Is the New Black.”

The losses are greater than those estimated by Tony Wible, an analyst with Janney Montgomery Scott.

“This is likely driven by the size of the new countries, France and Germany, and the market-specific initiatives,” Wible, who rates the stock buy and raised his target price for Netflix to $525 from $450, wrote in a research note.

In the second quarter, the company added 1.69 million online-video subscribers, beating its own forecast, to reach more than 50.05 million worldwide. International customers rose by 1.12 million to 13.8 million. Sales of smart TVs to World Cup fans in Latin America helped to lift sales in the region, Netflix said.

Going Global

The new season of the women’s prison show “Orange Is the New Black” emerged as a big draw, making the series the most-watched ever on Netflix and unseating “House of Cards.”

Net income more than doubled to $71 million, or $1.15 a share, from $29 million, or 49 cents, a year earlier, Netflix said yesterday on its website. That met the average of 30 analysts’ estimates compiled by Bloomberg. Sales, up 25 percent to $1.34 billion, also matched projections.

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Reed Hastings, chief executive officer of Netflix Inc. Close

Reed Hastings, chief executive officer of Netflix Inc.

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Photographer: Andrew Harrer/Bloomberg

Reed Hastings, chief executive officer of Netflix Inc.

“These are good numbers,” said Daniel Ernst, an analyst at Hudson Square Research in New York who recommends buying the stock. “But more importantly, it sets them up for future growth. It sets them up for the next 50 million as they go global.”

Global sports events have hurt Netflix in the past. Two years ago, the Summer Olympics cut into quarterly signups, trigging a drop in the shares.

Smart TVs

“What was incredible is just how straight our line of net additions were in Brazil, during the World Cup,” Hastings said yesterday on a video conference call after earnings came out.

The percentage of smart-TV viewing in Latin America is higher than any other region that Netflix serves, the company said. That’s important because Latin Americans viewing on big-screen televisions tend to watch more Netflix and be more loyal, according to Hastings.

“It’s probably that the smart TVs are relatively new and the kind of household that gets them is tech-oriented,” he said. “And then they get a great experience.”

Worldwide shipments of smart televisions are forecast to account for 73 percent of flat-panel TV sales by 2017, with virtually all mid- and high-priced sets having some Internet connectivity, Strategy Analytics said in January.

Critical Buzz

For the third quarter, the company forecasts total streaming revenue of $1.22 billion, a sum that excludes the older DVD-by-mail business. Analysts project revenue of $1.38 billion, including DVDs.

Netflix expects to add 3.69 million new customers, a pickup in growth that includes 1.33 million additions in the U.S. and 2.36 million overseas.

The company added 570,000 domestic streaming customers in the second quarter, seasonally the slowest, beating its forecast of 520,000 and lifting the U.S. total to 36.2 million.

Netflix is getting critical buzz for its shows, garnering 31 Emmy nominations this month and challenging premium pay TV networks like HBO and Showtime.

China Plans

The company is also making plans to enter China, which represents about a quarter of the almost 730 million broadband households that Netflix could address globally, according to Chief Financial Officer David Wells.

“Look for the future in terms of an answer from us in China,” said Wells said on the earnings webcast.

“It’s pretty early,” Wells said. China is “conspicuously large and it’s a conspicuously a growing and very strong economy.”

Netflix has said it is considering expanding into producing feature films that could run simultaneously in theaters and on the Netflix streaming service.

“The benefit is consumers having the choice, in the theaters if they want a big event out or in the home,” Hastings said. “But we haven’t figured out how to do that.”

Price Increase

Netflix began charging new customers $1 to $2 a month more for its online service during the quarter, reflecting confidence that original shows like the Kevin Spacey political thriller “House of Cards” would draw new viewers.

Hastings said in April that he expected little additional revenue from the change at first, and that the company would use the proceeds to invest in new content.

Netflix continues to see the potential for 60 million to 90 million U.S. customers and has said it eventually expects international revenue to exceed domestic sales.

“It’s really this growing demand for control and for the consumer to be able to click and watch what they want,” Hastings said on the call. “That’s why we’re stepping up on the international expansion. We really see this is an enormous moment in history as on-demand Internet services are coming to the fore around the world.”

To contact the reporter on this story: Sonali Basak in New York at sbasak7@bloomberg.net

To contact the editors responsible for this story: Anthony Palazzo at apalazzo@bloomberg.net James Callan

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