Netflix expected to post strong earnings

By David B. Wilkerson, MarketWatch

CHICAGO (MarketWatch) — Analysts anticipate another stellar quarter at Netflix Inc. when the company reports on Monday, spearheaded by increasing subscriptions to its digital streaming offering and the impact of further closures at the bankrupt Blockbuster video chain, but they’ll be listening closely for the company’s latest comments on rising content costs.

According to a survey of 25 analysts polled by FactSet Research, Netflix /quotes/zigman/87598/delayed/quotes/nls/nflx NFLX +2.53% is expected to earn $1.07 a share in the first quarter of 2011 on revenue of $705.7 million, a huge increase compared to the year-earlier profit of 59 cents on revenue of $493.7 million.

Netflix said in January it expects to end the first quarter with 21.9 million to 22.8 million U.S. subscribers.

Fueled by its spectacular subscriber growth and the increasing popularity of its online streaming product, the company’s stock has nearly tripled in the past year, and is up 39% in 2011. Given that run-up, most analysts are cautious about predicting further upside in the shares.

Over the last 100 days, the average recommendation of 26 analysts surveyed by FactSet is hold, with a target price of $225.26. The shares closed at $244.43 on Wednesday.

One additional source of hesitation stems from the fact that Netflix is in the process of ramping up the number of movies and TV shows available for streaming -- and that probably won’t be cheap. Right now, the company makes about 20,000 titles available for instant streaming. compared to more than 120,000 on DVD and Blu-ray.

Citigroup’s Mark Mahaney, who called the stock “one of a handful” of core holdings in the Mid-Small Cap Internet Sector, notes that it trades at 52 times greater than his estimate of 2011 adjusted earnings per share. Such a multiple “leaves little margin for error,” Mahaney commented in a research note on Thursday.

Mahaney expects Netflix to issue a second-quarter subscriber forecast of 23.6 million subscribers.

Among the other factors benefiting Netflix, Mahaney said, is that the number of Internet-enabled TVs and gaming consoles continue to grow, helping to drive “surprisingly strong” adoption of streaming.

Subscriber acquisition cost, a closely-watched metric for Netflix, is expected to rise to some degree, ending a pattern of decline at least temporarily. Mahaney expects SAC to rise to $11.50. The cost was $11.13 per subscriber in the fourth quarter of 2010 and $19.81 in the third quarter.

Cost of content for Netflix seen increasing

For Michael Pachter of Wedbush Morgan Securities, Netflix’s report on its latest three months of profit will be largely irrelevant.

With the stock hovering in the $80 range in April 2010, Pachter downgraded the shares to underperform from perform, with a target price of $73. Even after seeing the stock zoom into the $240s, Pachter is sticking to his rating, and a target price of $80.

Pachter’s contention has been that the fees Netflix pays to the movie studios to stream movies and TV shows will increase dramatically as the service gains in usage over the next two years, obliterating any savings the company realizes through the decrease of postage costs.

The analyst told clients this week that, based on Netflix’s recent deals with the premium movie channel Epix , Walt Disney Co. /quotes/zigman/245568/delayed/quotes/nls/dis DIS -0.29% , CBS /quotes/zigman/393390/delayed/quotes/nls/cbs CBS -0.72% and Fox, the company’s streaming costs will soar from an estimated $180 million in 2010 to a range between $1.69 billion and $2.27 billion by the end of 2011. None of the financial terms of those deals was disclosed. (Fox is owned by News Corp. /quotes/zigman/18008449/delayed/quotes/nls/nwsa NWSA -0.03% /quotes/zigman/18008448/delayed/quotes/nls/nws NWS +0.11% , /quotes/zigman/17601546/realtime AU:NWS 0.00% which is also the parent of MarketWatch, the publisher of this report.)

“We accept that our timing has been off for over a year, and acknowledge that it may be off for the next year or so,” Pachter wrote in a research note this week. However, we think that investors would be wise to acknowledge that Netflix will see its cost of content rise dramatically over the next two years.”

In that context, Pachter added, it hardly matters what Netflix will be shown to have earned in the first quarter of 2011. “Whether that figure is $1.00 or $1.25 [a share] , the stock currently trades at 50 – 60 times the implied annual run rate. Netflix is valued based upon a view that its earnings will grow to $10 a share in the foreseeable future, and will continue to grow from there.” Pachter continues to stress that he thinks this is unlikely to happen.

However, Eric Wold of Merriman Capital disagrees. Netflix, he told clients, “has been careful to sign [content] deals that can be covered by projected subscriber growth.”

In Wold’s view, near-term content costs could actually decline for Netflix, given the competition it will be facing in the streaming arena from Hulu, Amazon and others. “[S]ome studios/content owners may look to diversify through multiple providers to reach a larger audience,” Wold said to clients. “This is likely to reduce the average cost of content, not increase it.”

For now, Netflix would probably be willing to give up some exclusivity on certain streamed shows or movies in exchange for decreased content costs, Wold speculated.

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