We expect Q2 results in-line with our estimates for revenue of $791 million, ending subs of 25.7 million, and EPS of $1.15, compared with consensus for revenue of $791 million and EPS of $1.11. Q2 guidance is for revenue of $778 – 798 million, ending subs of 24.9 – 25.85 million, and EPS of $0.93 – 1.15.
We expect the company to limit forward guidance to Q3 due to the uncertainty caused by revised pricing, ongoing Starz (NASDAQ:LSTZA) negotiations, data caps, international rollout, and content costs. Netflix expects domestic operating margin of ≈ 14% for FY:11, positive Q3 operating margin for Canada (NYSE:EWC), and operating losses for international operations of ≈ $50 – 70 million in 2H:11.
Last week, Netflix raised the prices of its combination plans (unlimited streaming and DVDs by mail), and reintroduced unlimited DVDs by mail-only plans. The separation of unlimited streaming (still $7.99/month) from unlimited DVDs by mail has raised the monthly prices of each of the combo plans: 1 DVD out at-a-time now costs $15.98 (up from $9.99), 2 DVDs costs $19.98 ($14.99), and 3 DVDs costs $23.98 ($19.99). This is the second price increase in 8 months.
The long-term impact of and the reasons for new pricing remain unclear. We expect the impact of higher prices to be largely offset by customer migration to lower-priced plans, and expect limited postage savings. We think that Netflix bifurcated its subscriber base to gain leverage in streaming content negotiations.
Our central thesis—that streaming content costs are rising faster than revenues—appears to be confirmed by the price increases. Based upon recent deals, we believe that content costs are tracking to $2.2 – 2.5 billion in 2012, up from our earlier estimate of $1.6 – 2.2 billion. The launch of a streaming service in Latin America (NYSE:ILF) this year should add significantly to streaming costs.
Michael Pachter is an entertainment analyst at Wedbush Morgan.