Analyst: Netflix to Continue to Be Affected by State of Net Neutrality

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The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities. 

Netflix (NASDAQ:NLFX) will report first-quarter results after market close on April 21 and host a live video discussion at 2 p.m. Pacific (webcast: YouTube.com/NetflixIR). The discussion will again be moderated by two sell-side analysts.

Q1 results will likely meet or exceed the Street’s expectations, driven by House of Cards and cost control. Our estimates are for revenue of $1.273 billion versus consensus of $1.266 billion (no guidance), and earnings per share of 82 cents, in line with consensus, and guidance of 78 cents. We modeled domestic streaming subscriber net adds of 2.25 million, in line with guidance, but our bias is that our estimate may be too low based upon a high sign-up rate for season two of House of Cards, which debuted on February 14, and low Q1 advertising spending.

Q2 domestic streaming subscriber net adds guidance will likely be at or below last year’s 0.63 million versus our estimate of 0.5 million. Although management will likely attribute the decline primarily to seasonality, with less compelling exclusive content contributing to a slowdown, as Arrested Development debuted last May. We expect Q2 EPS guidance at or above consensus of $1, assuming that European expansion occurs in the second half of the year.

We believe Amazon’s (NASDAQ:AMZN) Fire TV announcement is a win for Netflix. Amazon listed Netflix ahead of its own Prime Instant Video (PIV) on the list of streaming apps available for the new box. In addition, Amazon did not introduce a standalone or ad-supported version of its streaming service. Finally, Amazon chose not to bundle PIV with Fire TV. We expect Netflix management to characterize Fire TV as a testament to the tremendous remaining market opportunity.

We expect management to complain about the state of net neutrality in the U.S. while downplaying the financial impact of interconnection agreements. In February, Netflix announced a multiyear interconnection agreement with Comcast, with undisclosed terms, but we believe that the expense is material. Although Netflix will likely infer that interconnections agreements largely reflect the greed of Internet service providers (ISPs) in a deregulated market, we expect Netflix to reach terms with the other ISPs in coming years in order to minimize throttling. Over time, we believe that interconnection agreements will force Netflix to raise prices, limiting the company’s growth potential.

Maintaining our UNDERPERFORM rating and 12-month price target of $175. Our price target reflects a sum-of-the-parts that values domestic streaming at $140, international streaming at $17 per share, and domestic DVD at $18 per share.

Michael Pachter is an analyst at Wedbush Securities. 

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