Netflix Set to Spin Off or Sell DVD Delivery Service

Netflix’s (NASDAQ:NFLX) decision to splits its DVD-by-mail service and its streaming-video service has paved the way for it to spin off or sell the former in order to focus solely on the latter moving forward.

A pure-play online business would be smaller and faster-growing, said George Askew, an analyst with Stifel Nicolaus & Co., and would have more freedom to experiment. Meanwhile, Netflix seems to be “actively trying to push people away” from its DVD business, says Tony Wible, an analyst with Janney Montgomery Scott LLC.

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“One business is global, one is domestic,” said Rich Greenfield, an analyst at BTIG LLC. “One is based on physical media and the other on digital. It’s about aligning the business up and down.” While Netflix has announced no plans to exit the mail order, the DVD service has less potential for growth, and CEO Reed Hastings cited the two services’ “different growth trajectories” in a blog post yesterday as the reason for the split.

Netflix said it has no plans to exit mail order and that the split reflects different growth trajectories. In a weekend blog post announcing the changes, Chief Executive Officer Reed Hastings apologized to customers over the handling of a July price change that boosted the monthly cost by 60 percent for subscribers who stream movies and rent DVDs by mail.

The DVD service is worth roughly eight to ten times earnings, or about $20 per Netflix share, according to Wible. Even with its steep decline since announcing subscription price hikes in July, Netflix is trading around $130 a share. For that reason, it would make sense for the company to choose to focus solely on improving its streaming service and improving content, but Wible thinks a sale of the DVD service is unlikely because Netflix would have difficulty in finding a buyer for what could soon become an out-dated service. He puts the odds of a sale or spinoff at less than 50%.

While 12 million of Netflix’s 25 million-plus customers subscribe to both the mail-order and streaming service, on a July conference call, Hastings said that he estimated the DVD business would decline by 10% a year going forward. On September 15, two weeks after its price hike went into effect for existing subscribers, the company trimmed its estimate of DVD-only subscribers to 2.2 million from 3 million, also lowering its forecast for streaming-only subscribers in the U.S. from 10 million to 9.8 million.

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Netflix may be pinning its hopes on the streaming service, but according to Youssef Squali, an analyst at Jefferies & Co, “If anything, the streaming service is probably weaker today than it was three months ago,” especially after the company lost access to Sony (NYSE:SNE) movies when contract negotiations with Starz (NASDAQ:LSTZA) fell through.