The Netflix Inc. (NFLX) camp will be heaving a sigh of relief, as the company has been acquitted in a class action law suit by a U.S District Judge, Phyllis Hamilton, in Oakland, California. The law suit dates back to 2009, when Netflix allied with retail giant Wal-Mart Stores Inc. (WMT) to monopolize the DVD rental market, thus compelling customers to pay inflated prices for subscriptions for the period between 2005-2010.
The District Judge ruled that the agreement between Netflix and Wal-Mart (already exited the online DVD market) did not have any impact on the pricing strategy of the rentals and the two companies had not indulged in any kind of antitrust violation. Moreover, the court also suggested that Wal-Mart’s market share being insignificant, could not have had any effect on Netflix’s pricing strategy.
While this was good news for Netflix investors, they remain wary about the fact that the company is raising $400 million in cash through stock offerings at $70 per share and convertible bonds. This seems to be a desperate move on the company’s part to expand its footprint in the international market, to primarily compensate for the massive subscriber churn in the domestic market.
Although the company foresees a profitable fourth quarter of 2011, subscriber growth is expected to remain flat. Netflix forecasts several quarters of losses starting from the first quarter of 2012, as domestic profits are not expected to be high enough to offset the expected losses from expansion into international markets. Netflix is further expecting a net loss for the fiscal year ending December 31, 2012, primarily due to relatively flat consolidated revenues and increased investment in the International segment.
We believe that the proceeds from the transaction will also help Netflix develop its streaming library, particularly in its domestic market, which will attract new subscribers going forward. However, an increasing debt level remains a concern, in our view. As of September 30, 2011 Netflix had cash and cash equivalents of $365.8 million versus a long-term debt of $200.0 million.
Further, the multi-year contracts with big Hollywood studios will require Netflix to pay approximately $3.5 billion for the rights to stream video over the long term. Netflix also expects these costs to increase going forward, which will remain an overhang on the stock in our view.
Additionally, intensifying competition from large players like Google Inc. (GOOG) and Amazon.com Inc. (AMZN) in the online streaming market is also a headwind, as it will further escalate license fees and affect subscriber additions over the long term.
We have an Underperform recommendation on Netflix over the long term (6-12 months). Currently, Netflix has a Zacks #3 Rank, which implies a ‘Hold’ rating in the short term.
