Netflix lowers U.S. subscriber forecast; shares fall

Thu Sep 15, 2011 5:32pm EDT

A screen grab shows the access to Netflix online, as displayed on a television screen, in Encinitas, California July 25, 2011. REUTERS/Mike Blake

A screen grab shows the access to Netflix online, as displayed on a television screen, in Encinitas, California July 25, 2011.

Credit: Reuters/Mike Blake

(Reuters) - Netflix Inc cut its third-quarter forecast by 1 million U.S. subscribers, sending its shares down nearly 19 percent, as the company known for rapid growth expects more fallout from a price increase on its DVD service.

On Thursday, Netflix said it would have 24 million subscribers at the end of the third quarter, down from a prior forecast of about 25 million given soon after the July announcement of the price increase.

The decision by Chief Executive Officer Reed Hastings to raise rates for customers who still want DVDs by mail took effect earlier this month.

Fewer customers than expected are opting to take Netflix's DVD-only subscription package. Netflix now expects to have 2.2 million such subscribers, down from the previous forecast of 3 million. The company also cut its forecast for streaming-only subscribers, to 21.8 million from 22 million.

Lazard Capital analyst Barton Crockett expressed concern that the changes might also hurt Netflix's fourth quarter.

"Clearly, if the third quarter is slipping, there's risk to the fourth quarter, as the year-ago period was a time when everything went right for Netflix," he said in a research note.

Crockett called the price increase a "rare, large and surprising misstep" by Hastings.

The decision to increase the monthly subscription for a joint streaming and DVD rental service by as much as 60 percent caused an uproar among customers and bloggers. For U.S. customers, the price for renting one DVD at a time plus unlimited streaming increased from about $10 a month to about $16 per month.

Netflix shares have fallen nearly 40 percent since the price hike was announced.

The Los Gatos, California, company, which is under pressure from Hollywood studios and pay-TV rivals because of its aggressive pricing, has argued that it sees the future in lower-cost streaming services.

Netflix's chief content officer, Ted Sarandos, said the pricing decision gave customers a chance to choose whether to keep DVD services or move to a cheaper streaming-only option. Previously only a combined service was offered.

"Being able to precisely forecast and predict the behavior of that many people on fairly radical change is something we'll get better at all the time," Sarandos said at the Paley Center for Media's International Council meeting on Thursday.

In a statement, Netflix said "we know our decision to split our services has upset many of our subscribers, which we don't take lightly, but we believe this split will help us make our services better for subscribers and shareholders for years to come."

UNDERMINING THE ECOSYSTEM

Hastings, who is also on the boards of Microsoft Corp and Facebook, is often seen as a visionary for building Netflix into a successful competitor first to Blockbuster and then, with the introduction of streaming, to traditional cable and satellite TV distributors.

But the cable and satellite TV companies have been pressuring Hollywood studios not to allow Netflix to undermine the $100 billion pay-TV ecosystem.

Netflix also faces growing competition in the streaming market from Amazon.com Inc, Hulu and others.

For DVDs, Coinstar Inc's Redbox kiosks offer an alternative, and Dish Network Corp's Blockbuster Inc is trying to lure disgruntled Netflix customers with a free trial offer. Coinstar shares rallied 7.2 percent to $48.49 on the Nasdaq on Thursday.

"There are other options popping up that may be attractive" to consumers, said Merriman Capital analyst Eric Wold, who has a "neutral" rating on Netflix and a "buy" on Coinstar.

Hastings now has to prepare himself for the possibility of another subscriber backlash as soon as February if Netflix loses some of its popular programing and movies.

Earlier this month, Starz ended talks to renew a deal that expires on February 28. After that, the pay-TV channel controlled by Liberty Media will stop providing its content, which includes exclusive streaming rights to first-run Sony Corp and Walt Disney Co movies such as "Toy Story 3" and "The Social Network."

Netflix "can't grow as fast as the Street thinks," said Wedbush Securities analyst Michael Pachter, who rates the company's stock at "underperform." "They can't have the perfect world where content stays cheap and people sign up at low prices."

However, Netflix maintained its third-quarter financial outlook as well as its international subscriber forecast.

The company's stock fell 19 percent to close at $169.25 on Nasdaq.

(Reporting by Yinka Adegoke in New York and Lisa Richwine in Los Angeles, additional reporting by Liana Baker in New York and Supantha Mukherjee in Bangalore; Editing by Maju Samuel, Lisa Von Ahn and Matthew Lewis)