Netflix stock downgraded on growth limitations

DIGITAL: Nintentdo streaming agreement may be reached 'soon,' analyst says

By Danny King -- Video Business, 11/24/2009

 NOV. 24 | DIGITAL: Netflix shares might fall more than 15% because earnings growth will be limited by lower subscription rates from customers who only stream content and by studios' efforts to get higher rates for digital-title rights, according to Wedbush Morgan analyst Michael Pachter. He added that Netflix might reach a video-streaming agreement with Nintendo for its Wii games console "soon."

Netflix, the biggest U.S. movie-rental service via mail, is worth about $50 a share, or 17% less than the company's closing share price yesterday of $60.38, Pachter wrote in a note to clients this morning. He downgraded the company's stock today to "underperform" from "neutral."

Netflix's average revenue per user will be constrained as more customers join Netflix specifically for its unlimited video-streaming plans, and the company's cost of goods sold might rise as studios try to get higher prices for digital title rights, according to Pachter. Netflix estimates that it will maintain a 10% operating margin as it invests more in its video-streaming service.

"It is clear that Netflix’s streaming initiative is driving subscriber growth and helping margins, but this growth has attracted the attention of the movie studios," Pachter wrote. "The studios are seeking higher payments for streaming content, and Netflix’s 10% margin cap appears to us to be a concession to the studios."

Netflix said last month that its third-quarter profit jumped 48% as the company both boosted sales and broadened its subscriber base on the combination of its DVD rentals and video-streaming services. The company, which widened its subscriber base 28% from a year earlier to 11.1 million, also said that about 42% of its customers video-streamed at least one title during the third quarter, almost double the year earlier estimate.

Since the day before the Oct. 22 earnings announcement, Netflix shares have surged 26%. Netflix's stock is down about 1% today.

The company will likely further boost its video-streaming contingent after announcing with Sony Computer Entertainment America last month that it would provide subscribers with Blu-ray discs that, when installed in PlayStation 3 consoles, provides access to Netflix's inventory of more than 17,000 titles. Netflix, which previously had an exclusive video-streaming agreement with Microsoft for its Xbox 360 consoles, might reach a similar agreement for Nintendo's Wii, according to Pachter.

"We expect Netflix to announce a partnership with Nintendo for streaming on the Wii soon, creating a much larger potential audience for Netflix’s streaming service," Pachter wrote.

Netflix executives have repeatedly declined to comment on any potential agreement with Nintendo.

Before today, 13 financial analysts had "buy" or "strong buy" ratings on Netflix, 12 had "hold" ratings and six had "underperform" or "sell" ratings.