Earlier today, in an entry on the Netflix (NASDAQ:NFLX) blog, CEO Reed Hastings announced that the planned separation of the company into Netflix.com (a streamingonly business) and Qwikster.com (a DVD-by-mail business) would no longer
occur due to customer displeasure with the separation.
This morning’s announcement concludes a difficult three-month period for Netflix (NASDAQ:NFLX). On July 12, it announced the separation of its streaming and DVD plans (raising the price of its most popular combination plan by 60%), and the reintroduction of DVD-only plans. On September 15, it lowered Q3:11 domestic subs guidance to 24 million from 25 million, and on September 18, it announced plans for the complete separation of Netflix into Netflix.com and Qwikster.com.
We believe today’s announcement signals an end to the possibility of Amazon.com (NASDAQ:AMZN) acquiring Netflix’s streaming business. In a September 22 note, we speculated that Netflix had separated into two companies to allow Amazon to purchase the streaming business without establishing physical nexus in multiple states. By avoiding physical nexus, Amazon would not have to collect sales tax. Additional key drivers of a purchase included: strengthening Amazon Prime, securing scarce content, eliminating competition, and providing Netflix.com with the financial resources to renew its Starz (NASDAQ:LSTZA) agreement and secure additional content.
We believe Netflix’s (NASDAQ:NFLX) precipitous share price drop and additional customer attrition caused Amazon to back away from a potential deal. Netflix shares have traded above $200/share for most of the past year, but closed on Friday, October 7 at only $117.21. In our view, given that the separation steps began in July 2011, Amazon likely agreed to a purchase price well above $200/share, with a large break-up fee in place. We believe Amazon (NASDAQ:AMZN) could no longer justify a purchase price exceeding $200/share given Netflix’s current share price and likely additional customer attrition from the continuing backlash.
We are downgrading Netflix (NASDAQ:NFLX) to NEUTRAL from OUTPERFORM, and lowering our 12-month price target to $110 from $155. Our revised price target reflects 20x our FY:12 EPS estimate of $5.38, a multiple in line with the company’s longterm growth rate.
Michael Pachter is an analyst at Wedbush Morgan.