We are lowering our rating on Netflix (NASDAQ:NFLX) to UNDERPERFORM from NEUTRAL. In our view, the company’s business model was broken when it raised prices for its hybrid customers, and continued customer defections will require it to invest ever-increasing amounts on marketing.
We expect content costs to continue to rise. We estimate that Netflix will spend $800 million on streaming content in 2011, and expect streaming content costs to rise to at least $1.7 billion in 2012, partially offset by approximately $200 million in DVD and postage savings.
Netflix (NASDAQ:NFLX) continues to lose customers as a result of its recent price increases. The company raised pricing for its hybrid plans in September, triggering mass defections and trade downs, and sharply limiting the attractiveness of the service to new customers.
We are particularly concerned by the company’s “growth at all costs” business model. Netflix management is willing to incur losses for all of 2012 in order to chase international expansion; we think that international subscribers will generate losses for the foreseeable future at a time when the company has alienated its most profitable domestic customers with its sharp price increases, further challenging its profitability.
There may be no bottom to the company’s 2012 losses. Faced with escalating content costs and higher planned marketing spending due to its international expansion, we think that Netflix could deliver results well below the consensus estimate of a profit of $0.59/share; we expect a loss per share of $0.35, and think that our estimate may prove to be exceedingly conservative.
Maintaining our 12-month price target of $45. Our price target reflects 15x our FY: 13 EPS estimate of $3, a level of earnings we view as attainable once the company has lowered international spending and revised its unpopular pricing structure. Our multiple is in-line with the company’s long-term growth rate.
Michael Pachter is an analyst at Wedbush Morgan.