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Netflix subscriber growth narrows

October 20, 2008 |  4:51 pm

Reedhastingsappaulsakuma_2 Netflix Inc. investors are realizing that even cheap entertainment isn’t entirely immune to a recession.

Although the Los Gatos, Calif.-based DVD rental company’s revenue increased, thanks to a bigger subscriber base, subscriber growth declined 9% in the quarter ended Sept. 30 compared to the same period last year. Netflix had lowered its expectations in an announcement earlier this month.

The company also lost subscribers at the same rate as last year. Netflix had anticipated higher retention as consumers grew more accustomed to the Web-driven Netflix model of paying a monthly fee for all-you-can-watch movies by mail and by instant stream.

Still, the news isn’t too bad overall. Revenue increased 16% to $341.3 million, and total subscribers grew 23% to 8.7 million. Net income increased 31% to $20.4 million, or 33 cents a share. That beat the expectations of analysts surveyed by Bloomberg by 2 cents. 

The economy wasn’t Netflix’s only problem during the third quarter. Must-see television events like the August Olympics and the political conventions lured viewers away from rentals, and Netflix had a brief shipment stoppage (which also cost the company $6.5 million in customer credits).

And Netflix might be better positioned than most companies to weather the credit-crunched months ahead, thanks to its solid subscriber base and its adoption of new technologies.

Companytown “The good news for Netflix is that they don’t necessarily have to grow subscribers to keep the business on track in any given quarter,” says Piper Jaffray & Co. analyst Mike Olson. “Netflix definitely has a strong, recurring, high cash-flow business model.”

Netflix is also starting to offer customers more ways to watch. Twelve thousand titles can be streamed instantly online — including recently added content from CBS, Disney-ABC Television Group and Starz Entertainment. And though there are only about a thousand titles so far, Netflix is trying to offer more content in the higher-definition Blu-ray format, for which it will charge subsribers a dollar extra per month, adding slightly to its revenue next quarter.

And this year Netflix announced a series of partnerships with consumer electronics companies that will make it easier for subscribers to watch movies instantly on their TVs through Roku set-top boxes, LG Electronics’ Blu-ray players, and soon via Xbox 360 video game consoles.

“The most important piece of the Netflix story going forward is its ability to get its technology on consumer electronics devices,” Olson says, “I think they’ve done a great job out of the gates, but ultimately they need to be on hundreds of devices.”

Olson thinks that expansion isn’t necessarily out of Netflix’s reach, and, if consumers switch from discs to instant streams, could lower the company’s operating costs.

Wedbush Morgan Securities analyst Michael Pachter agrees, calling that switch “nirvana for Netflix.”

“We have fewer discs, streams don’t break — discs do — and we have no postage. We can pay the studios even more, and the customer gets immediate gratification,” Pachter says, speaking from Netflix’s perspective.

But Netflix Chief Executive Reed Hastings doesn’t seem optimistic that perfect substitution will happen, at least not any time soon.

“We’ve seen a growing adoption of ‘watch instantly’ [Netflix’s streaming option] and we expect that to continue,” he says. “[But] you can’t see a drop-off in DVD usage because the people who go for online streaming are a different type of person.”

The company expects to have between 8.85 million and 9.15 million subscribers in the fourth quarter, lowered from its previous estimate. But its net income prediction remained steady at between $18 million to $23 million. 

Netflix shares were steady at $23.80 in after-hours trading on the Nasdaq, following the earnings announcement.

--Swati Pandey

*Photo of Netflix Chief Executive Reed Hastings courtesy Paul Sakuma, Associated Press.