Netflix faces Apple challenge – Needham & Co.

Needham & Co has raised its estimates on Netflix from $22 to $25 per share, raising assessment on the stock from underperform to hold.
Netflix is the world’s largest online movie rental service, providing more than eight million subscribers access to over 100,000 DVD titles. The company offers a variety of subscription plans, starting at $4.99 a month. There are no due dates, no late fees and no shipping fees.
Analyst Charles Wolf explained the company’s previous models for Netflix performance needed some revision, and notes some challenges for the company’s attempt at offering online film services, a la Apple or Amazon.
“First, the mix of videos in its digital library is skewed to catalog titles rather than new releases. In contrast, Apple’s iTunes movie delivery service is tilted to new and recent releases,” the analyst points out. “We suspect that Netflix was partially motivated in its decision to focus on older releases by the lower costs of older films.
“Second, Netflix’s service is currently much cheaper than Apple or Amazon. Apple and Amazon charge $4 for a new release rental and $3 for an older title. Netflix is allowing subscribers unlimited digital downloads if they’ve subscribed to the one-out or higher plans. The company hopes that subscribers using its digital service will rent fewer movies through the mail, thus offsetting some of the costs associated with unlimited rentals. However, Netflix’s unlimited download scheme does have unintended consequences. Because they have access to unlimited downloads, some Netflix subscribers have downsized their subscription plans, substituting a 1 DVD-out for 3 DVDs-out to save money even as they watch as many if not more movies.
“Third, Netflix is betting on a virtuous circle—that unlimited downloads will stimulate demand and in turn, encourage more manufacturers to build direct-to-TV Netflix boxes. The company believes that a wide choice of boxes will eventually attract new subscribers to the Netflix service. Unfortunately, there is little, if any, logic underlying this belief,” Wolf observes.
“The competitive reality is that unlike the DVD-by mail market, Netflix is likely to face considerable competition in the digital distribution market. Apple recently announced that it’s selling or renting 50,000 movies daily, despite a quite limited selection compared to Netflix.”
He points to the imminent debut of Amazon and Blockbuster on the market, warning, “In the short run, Netflix’s strategy of allowing unlimited downloads to most of its subscribers is a risky one. Since it receives no payments for the downloads, the company loses money on every download irrespective of the lower costs incurred in streaming older movies. Indeed, if the digital delivery service takes off without a concomitant reduction in by-mail rentals, Netflix will have little choice but to set up a separate service for digital delivery. We suspect that such a service will be used more frequently than the company’s by-mail offering because it offers instant gratification. As such, then, it’s likely to be less profitable than Netflix’s by-mail subscription service.”

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