Netflix Sub Slowdown Sends Stock Spiraling

Despite beating earnings forecasts for the second quarter, Netflix saw its stock tank after hours on Monday -- down as much as 16% -- on news that the company badly missed revenue and subscriber targets.

Netflix Inc. (Nasdaq: NFLX) reported earnings per share of 9 cents, well above its EPS prediction of 2 cents per share. However, total revenues came in at $1.97 billion for the quarter, below analyst forecasts of $2.1 to $2.2 billion. And Netflix added only 1.7 million new subscribers in Q2, which was nowhere near the company's estimate of 2.5 million subscriber additions.

In a subdued quarterly earnings call, Netflix executives blamed poor subscriber growth on the company's continuing effort to move customers away from grandfathered pricing plans. CEO Reed Hastings suggested that "un-grandfathering" was perceived by the public as an overall price increase which boosted customer churn. As evidence, he cited a particular uptick in churn immediately following press reports that older pricing plans were being phased out. Hastings added that he doesn't believe the company's slower growth is a result of market saturation, noting that gross additions are still healthy, and that increased churn in the quarter took place even in markets like Canada where competition from other over-the-top services is limited.

In Netflix's quarterly letter to shareholders, the company also highlighted the distribution partnerships it now has with 40 multichannel video programming distributors (MVPDs) as a sign of its success. In its latest deal, Netflix signed an agreement with Comcast Corp. (Nasdaq: CMCSA, CMCSK) to integrate the Netflix service on the cable operator's X1 video platform. However, Hastings said he does not believe the Comcast partnership will have any impact on next quarter's earnings report. The service is expected to launch on X1 before the end of the year, but the two companies are still working on the integration process. (See Comcast Confirms Netflix Coming to X1.)

As far as near-term projections go, Netflix is forecasting a net increase of 2.3 million subscribers in Q3 and total streaming revenues of $2.12 billion. Its earnings estimate falls at 5 cents per share.

Netflix attributes its better-than-expected earnings in Q2 to "lower than expected content and other costs." It's possible that some of those lower costs can be attributed to improved bandwidth optimization. The company has implemented new encoding techniques in recent months that determine what bitrate a streaming title needs based not only on how much bandwidth is available, but also on the type of video being shown. (See Netflix Isn't the Only One Rethinking ABR.)

Netflix's share of peak Internet traffic actually decreased in the spring, according to Sandvine Inc. , to 35% from 37% last fall. Hastings said he believes that decrease correlates with "what we think was the increase in encoding efficiency."

In other words, even though consumer usage continues to grow, bandwidth needs have declined, which means potentially higher margins for Netflix.

Hastings was also asked in the earnings call about news reports that Netflix is planning to launch a download-to-go feature much like Amazon.com Inc. (Nasdaq: AMZN) offers today. (See Netflix Queues Up Video Downloads.)

The CEO's response was typically non-committal. "We're open-minded about it," said Hastings.

— Mari Silbey, Senior Editor, Cable/Video, Light Reading

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