Netflix Falls Most in 2 Years as HBO Plots Online Service

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Netflix Inc. tumbled the most in more than two years after saying a price increase slowed subscriber growth, while coming competition from HBO gives the world’s largest subscription-streaming service a new challenge.

Netflix slid 19 percent to $361.70 at the close in New York, the biggest drop since July 2012, after reporting third-quarter user numbers yesterday that fell short of its forecast. The Los Gatos, California-based company blamed a recent $1 price increase for the shortfall, and offered a guarded outlook for this period.

Chief Executive Officer Reed Hastings is grappling with a slowdown in U.S. growth just as cable channels such as HBO are crowding into the market Netflix pioneered. Time Warner Inc.’s HBO said yesterday it will offer a streaming video service independent of pay-TV subscriptions next year. Others, including CBS Corp.’s Showtime, said they may also do so, creating more competition for Netflix.

“We’ll see a really fun couple of years where the two of us compete for the best content, the most Emmys, the subscriber growth, and many, many people will subscribe to both services,” Hastings said yesterday on a call after the earnings report. “We’re looking forward to that.”

The challenges are triggered partly by Netflix’s success. As an outsider upsetting the pay-television industry with its online streaming service, Netflix racked up a sensational expansion of its business and stock gains that led the Standard & Poor’s 500 Index for the six years from 2008 to 2013. Now so many people are watching TV over the Internet, it’s harder for Netflix to add customers in the U.S., and competitors who once derided the company are targeting its market.

Tepid Forecast

The drop in the shares recalls a 15-month decline the stock suffered starting in July 2011, triggered when Netflix raised prices and tried unsuccessfully to split its DVD-by-mail business into a separate company. Subscribers revolted and the shares continued to drop until billionaire Carl Icahn acquired a stake and customer growth picked up.

The streaming service added 980,000 U.S. customers in the period ended Sept. 30, fewer than a year ago and short of a July projection of 1.33 million. Additions outside the U.S., where the company is expanding rapidly, amounted to 2.04 million, also missing forecasts.

Sales, including the DVD-by-mail business, grew 27 percent to $1.41 billion, Netflix said. Net income almost doubled to $59.3 million, or 96 cents a share, from $31.8 million, or 52 cents, a year earlier. Analysts projected 91 cents.

Subscriber Forecast

This quarter, Netflix said it will add 4 million subscribers around the world, including 1.85 million in the U.S., a slowdown from the 2.33 million recorded a year earlier. The company predicts fourth-quarter profit of 44 cents a share, compared with the 84-cent average of 35 analysts’ estimates compiled by Bloomberg. They estimate sales of $1.5 billion.

Hastings remains confident his company will meet previous projections of 60 million to 90 million U.S. subscribers over the long term, and said growth oversees has accelerated.

“International is growing very fast; it easily overwhelms U.S. flatness,” Hastings said in an interview.

Knock Knock

The arrival of HBO at his doorstep indicates others agree with Hastings’s view of TV’s future. Inc. and Hulu, which is owned by three big media companies, have tried to replicate Netflix’s success.

“This is an incredible validation,” Hastings said. “We outlined the thesis two years ago in our long-term investor letter about Internet video becoming all of video and replacing linear TV.”

The TV industry was at first reluctant to credit Netflix. Time Warner CEO Jeff Bewkes once referred to the company as the Albanian army.

Media executives changed their tune after Netflix’s subscriber base and share price soared. With more than 36 million paid U.S. customers, Netflix now boasts more domestic subscribers than HBO.

New Audience

HBO is seeking to expand beyond its existing 31 million U.S. customers, CEO Richard Plepler said at a Time Warner investor meeting yesterday, and will mount its first marketing push in two decades, including support for the standalone service’s debut next year. The company already operates an on-demand service, HBO Go, for pay TV customers.

“It is time to remove all barriers to those who want HBO,” Plepler said.

The premium channel is one of Time Warner’s most profitable business, with operating income of $1.79 billion last year and revenue of $4.89 billion.

The gradual shrinkage of the pay-TV business impelled HBO to embark on a new path. Younger viewers subscribe to cable at a lower rate than their parents, and analysts forecast a decline in pay-TV subscriptions in the years ahead.

“You’ve got two choices: you either milk it into decline for a very long period of time, or you figure out how to become a multiplatform provider,” John Rose, leader of the media practice at Boston Consulting Group, said in an interview. “The issue isn’t where does HBO start, but forgive the pun, where does HBO Go.”

Pay-TV Strains

Competing premium cable channels Starz and Showtime will probably follow HBO’s lead, said Tony Wible, an analyst with Janney Montgomery Scott LLC who recommends Netflix shares.

“Everyone will explore this,” Wible said. “There are real strains on the existing TV ecosystem, and people have to find new ways of monetizing their content.”

CBS today announced its own digital-subscription service that will offer video streaming of thousands of TV episodes from current and previous seasons, according to a statement. CBS All Access, which will cost $5.99 per month, also lets viewers watch the network’s local TV stations live in 14 of the largest U.S. markets.

Showtime, Starz

Neither Showtime, part of Sumner Redstone’s media empire, nor Starz, controlled by billionaire John Malone, has announced plans for a direct-to-consumer video service in the U.S. Showtime said yesterday it’s been studying offering its shows outside of the pay-TV bundle. Starz recently unveiled plans for an international streaming service, which Hastings said may augur a domestic product as well.

None of the competitors boasts a library of TV content comparable to Netflix, which generates the majority of its viewing from shows like “Breaking Bad” and its own “House of Cards.” Netflix said yesterday its commitment to spending on shows and movies totals $8.9 billion over several years.

“As you move to the Internet, you’re moving into our area of strength,” Hastings said.

Netflix often identifies HBO as a model for its own trajectory. Both are premium channels that used film reruns to gain customers and fund compelling original programs. Netflix had been singular in one respect: it is available to anyone, including those without a traditional cable package.

“Netflix has been fully anticipating a day where HBO and Netflix look very similar to one another,” Wible said. “They are both going to the same spot from different directions.”