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Wedbush analyst is no Netflix hater

Michael Pachter says he likes Netflix, but he isn't crazy about the idea of spending big to build a streaming-movie service.

Michael Pachter, an analyst with Wedbush Morgan Securities, said Tuesday that he likes Netflix and has no wish to see the company kill its nascent streaming movie service.

I wrote Monday that Pachter was being too short sighted by questioning the size of Netflix's investment in a streaming-movie service. After reading the research report Pachter issued last week, I believe his arguments deserve closer examination.

Quotes from Pachter appeared in a story last week in (via about how the costs of establishing a digital rental service are making some Netflix investors nervous. Pachter speculated in the story that if Netflix was spending $70 million on a service that may have only 100,000 users it would cost the company $700 per customer. He called such spending "crazy" and said the strategy was attractive only when large numbers of users were involved.

He said much the same thing in his report: "If there are fewer than 1 million regular users," Pachter wrote, "the cost per user may be significantly higher, and we would be far more likely to criticize the investment."

His doesn't know exactly how many subscribers use Netflix's streaming service because the company hasn't disclosed those numbers and Pachter has called on managers to offer details.

In the report, Pachter makes clear that while he is skeptical about a download-to-rent business model (ala Apple) he thinks Netflix's idea of wedding a streaming-video service to its traditional DVD-by-mail business "borders on brilliant." He called Netflix's management "smart, resourceful, and at times visionary." He added, however, that there should be limits to how much the company spends on building a digital distribution.

"In our view, spending $2-5 per month per user (of the streaming service) may be justified to build loyalty...this implies usage of between 1 (million) to 3 million users."

I think it's a mistake to fence in Netflix CEO Reed Hastings here. The company is facing a dramatic technological shift that could render its traditional mail-order business obsolete. I don't think you can read too much into Reed's prediction last week that Netflix's DVD business will peak in five years.

The stakes are too high and too many signs indicate that movie-rentals are going digital for Netflix to skimp The latest example of the transition came Tuesday when Roku, the company that makes the Netflix Player, a device that enables Netflix customers to watch streaming video on their TV sets, said it sold out of the boxes only two weeks after they went on sale.

Someone soon is going to come up with a service that provides reasonably priced movies in HD quality and deliver them straight to consumers' TV sets. This is a more convenient way to rent movies and Netflix knows the power of convenience.

After all, didn't the company grow to prominence in part by helping people avoid the drive to the local video store?