(NFLX) Netflix Earnings Preview

Netflix Inc. (NFLX) is scheduled to release its fiscal first-quarter 2012 results after the closing bell on Monday, April 23, 2012. In the run up to the earnings results, no substantial movement in analysts’ estimates for the quarter was noticed.

Prior Quarter Recap

Rebound in subscriber growth helped Netflix report robust fourth quarter results. At the end of fourth quarter 2011, total numbers of subscribers (Domestic and International) were 26.3 million, an increase of 31.5% from the prior-year quarter. Most importantly, subscriber growth rebounded in the reported quarter after the company lost 800K subscribers in the third quarter.

Domestic revenue increased 43.0% from the year-ago quarter to $846.6 million, which surpassed management’s guided range of $816.0 to $845.0 million. International operations generated revenues of $29.0 million, up 27.8% year over year and were at the higher end of management’s guided range of $25.0 million to $30.0 million.

Netflix’s fourth quarter diluted earnings of 73 cents per share, breezed past the Zacks Consensus Estimate of 55 cents per share and management’s guidance range of 36 cents to 70 cents. However, EPS declined 16.1% year over year, primarily due to higher operating expenses in the quarter.

Operating expenses shot up 81.2% year over year to $229.5 million, due to higher marketing expenses (up 81.8% year over year), technology and development expenses (up 75.8% year over year) and general and administrative expenses (up 93.0% year over year) in the quarter.

Quarter Ahead

For the current quarter, management expects loss per share to be in the range of 49 cents to 16 cents. The Zacks Consensus EPS Estimate is pegged at a loss of 27 cents per share. Net loss is expected to be in the range of $27.0 million to $9.0 million.

Domestic and International revenue is expected to be in the range of $496.0 million to $511.0 million and $38.0 million to $44.0 million, respectively. Domestic DVD revenue is expected to be in the range of $308.0 million to $322.0 million for the first quarter of 2012. For the quarter, the Zacks Consensus Estimate projects Netflix to earn revenues of $867 million.

Management expects subscribers in the consolidated domestic market and in the international market to range from 22.8 million to 23.6 million and from 2.5 million to 3.1 million, respectively. The U.S. DVD subscriber base is expected to be in the range of 9.4 million to 10.0 million.

Management expects the subscriber growth to be negatively impacted by increasing attrition rate in the DVD segment. However, management expects strong growth in streaming customer base in both US and International in 2012.

Estimates Trend Revision

Over the past 30 days, none of the 28 analysts covering the stock revised their estimates for the quarter. Thus, the Zacks Consensus Estimate for the first quarter is been pinned at a loss of 27 cents per share.

Analysts covering the stock expect the video streaming market to be competitive for Netflix with some of the bellwethers like Amazon.com Inc. (AMZN), HBO and Verizon Communications (VZ) entering the arena. Moreover, content costs are on the rise with the company going for new agreements with production houses to enhance its content library. Additionally, analysts opine that the international expansions (UK and Latin America) could take time to be profitable.

However, analysts also believe that continued subscriber additions could somewhat offset the lower profitability in the near term.

Our Take

We note that Netflix has performed consistently during the last 4 quarters with its average earnings surprise being 18.02%. For the to-be-reported quarter we expect the company to beat the Zacks Consensus by the same magnitude.

Netflix’s offering of new and exclusive content to its subscribers are its biggest USP compared to some of its closest peers. Apart from recent movies and documentaries, Netflix is also boosting its original content portfolio to entice new subscribers in the US market and international market.

However, higher capital expenditure due to international expansion will hurt earnings growth in the near term, in our view. Moreover, when compared to some of its cable and communications peers that have diversified revenue and cash flow streams, Netflix relies solely on streaming for future growth, as its DVD rental business continues to lose subscribers.

We believe that the streaming market is getting overcrowded and this will hurt Netflix’s margins going forward. We provide a word of caution to investors in this respect.

We have a Neutral recommendation on Netflix over the long term. Currently, Netflix has a Zacks #3 Rank, which implies a Hold rating in the short term.

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