Why Does Wall Street Hate Netflix?

Why Does Wall Street Hate Netflix?
Why Does Wall Street Hate Netflix?

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Everyone seemed to love Netflix (NFLX) just six months ago. The all-you-can-eat video service was a hit with couch potatoes, offering a cost-effective way to consume the latest releases on DVD and a growing catalog of digital content as streams.

These days Wall Street isn't feeling a whole lot of love for Netflix: Just 17% of the 35 established analysts tracking Netflix have it tagged with a "buy" or "strong buy" rating.

Fall From Grace

How did a dot-com darling become a dot-com dud?

Netflix's downfall has been well documented. First, the company alienated subscribers this past summer when it revealed that it would raise its monthly rates by as much as 60%.

Analysts originally loved the move, waxing bullish on the margin-widening potential of meatier subscription revenue. But Wall Street and CEO Reed Hastings underestimated the resistance. As a result of the price hike, which kicked in for active customers during their September billing cycle, Netflix closed out the third quarter with 800,000 fewer domestic subscribers than it had when the quarter began.

In a few weeks we'll get the full report on the company's fourth-quarter performance, but no one should be surprised if Netflix had another crummy quarter.

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We also had the Qwikster fiasco. Just as investors were reeling from the harsh response to the price hike on subscribers to Netflix's dual plans -- those receiving optical discs and streaming video -- the California company announced it would be splitting its operations into two distinct websites. Netflix would remain the streaming hub, but folks renting DVDs and Blu-rays would be migrated over to Qwikster.

The already-tender subscribers were outraged. Why should they have to manage two independent queues on two different sites? Wasn't it bad enough that they were already paying more?

Subscribers who may have been on the fence likely bolted in droves at that point. Netflix did the right thing -- killing off Qwikster just three weeks after it was announced and before the operations were actually split in two -- but the damage was done.

Netflix's reputation went from golden to checkered. Analysts -- realizing that fewer incensed subscribers paying more wasn't going to be a very compelling model -- changed their bullish tune.

Netflix went from loved to loathed just like that.

Misunderstood Intentions

Netflix was never as evil as the subscribers taking a battering ram to the company's reputation may have made it seem.
Netflix was too good to be true at $9.99 a month for an unlimited DVD rental service with an expanding digital catalog that was proving to be expensive to maintain. Studios were demanding more money out of Netflix for stream licensing rights, and Netflix had been offering that at no additional cost to subscribers on unlimited DVD plans since 2007.

The plan seemed fair. Streaming was no longer supportable as a "free" bonus for DVD subscribers. Netflix chose to drop the monthly price of the unlimited DVD service to as little as $7.99, but customers wanting access to the growing streaming catalog across an equally growing array of devices would have to pay $7.99 a month as well. This leap -- from $9.99 to $15.98 a month -- is why folks began decrying the 60% hike, but in reality, customers who were fine with just DVDs were actually treated to a price cut.

Qwikster was a bad idea. It was indefensible and poorly thought out. However, Netflix's willingness to add video games to Qwikster -- something that was abandoned when the split was shelved -- was never rightfully applauded.

The Long Road to Redemption

Shares of Netflix would have to more than triple to regain their summertime highs, and that's unlikely to happen in the near term. Netflix is now bracing investors to expect a loss for all of 2012. Rolling out in the U.K. and Ireland earlier this month will naturally be a drag on profitability, but the company has conceded that its stateside business is also in a funk.

Let's face it: Wall Street isn't going to renew its love affair with Netflix until it begins turning a profit and starts growing its subscriber count again.

It won't be easy. Competition is brewing for Netflix in 2012. Amazon.com (AMZN) has been growing the number of streaming titles available to Amazon Prime shoppers, and unlike Netflix, it doesn't charge more for the perk. Coinstar's (CSTR) Redbox and even FiOS parent and wireless darling Verizon (VZ) have been reportedly linked to launching streaming smorgasbords later this year.

The one thing working in Netflix's favor is that it takes time and money to amass the kind of digital vault that the company has built over the years. Stability in Netflix's subscriber count should kick in as soon as this new quarter.

Analysts have every right to be skeptical. Netflix has packed a corporate lifetime's worth of boneheaded decisions into just a few months. However, Netflix did kick off 2012 with back-to-back weeks of hearty stock gains.

Someone's apparently ready to believe in Netflix. Wall Street will probably be the last to know.

Longtime Motley Fool contributor Rick Munarriz does not own shares in any stocks in this article, except for Netflix. The Motley Fool owns shares of Amazon.com and Apple. Motley Fool newsletter services have recommended buying shares of Apple, Netflix, and Amazon.com, as well as creating a bull call spread position in Apple.

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