Blame Netflix troubles on spotty streaming selection

CEO says slower subscriber growth in second quarter is seasonal but Wall Street isn't sure. Investors fear decline in growth tied to lack of streaming content and increased competition.

Greg Sandoval Former Staff writer
Greg Sandoval covers media and digital entertainment for CNET News. Based in New York, Sandoval is a former reporter for The Washington Post and the Los Angeles Times. E-mail Greg, or follow him on Twitter at @sandoCNET.
Greg Sandoval
3 min read
Here are the top five action films Netflix suggests I watch. Three of them are at least 20 years old. 'Giant' is a classic that I've seen a dozen times. Can Netflix continue to add subscribers with a lineup like this? Netflix/Screen shot Greg Sandoval

The first thing to know about Netflix is that CEO Reed Hastings says the business is in good shape.

The next thing to know is that hardly anyone on Wall Street believes him.

Netflix shares toppled last night 16 percent to $85.45 after the Web video-rental service issued first-quarter earnings and projected light subscriber growth for the company's streaming service in the second quarter. For the first three months of the year, Netflix added 1.7 million new streaming subscribers.

"The business is performing exactly as we had hoped," Hastings told analysts following the company's first quarter earnings report. "We're continuing to execute on all of the key dimensions."

Yet, the company predicts it may add as few as 200,000 new streaming customers in Q2 and at most 800,000. During the analyst call, Hastings appealed for calm and said the problem was temporary and seasonal. The second quarter is typically tough on Netflix. Skeptics, however, worry that the problems could be more lasting and have more to do with the company's inability to secure film licenses and growing competition in the streaming-video sector.

"I don't think anyone is ready to give Netflix the benefit of the doubt at this point," Aaron Kessler, an Internet analyst with Raymond James, told The Associated Press.

For the quarter, Hastings accomplished almost everything Wall Street asked. The company reported a net loss of $5 million, smaller than expected and said it would return to profitability faster than anticipated. Revenue of $870 million was in line with projections.

Not enough.

Wall Street knows that Netflix's business model can't afford any prolonged slows downs in subscriber additions. Remember that "virtuous cycle" Hastings crowed about the past two years? The formula went something like this: more titles = more subscribers = more revenue = more titles and back round again. All Netflix had to do to keep the wheel turning was continue writing checks for new films and TV shows.

But licensing costs have gone through the roof. Netflix failed to renew a licensing agreement with Starz, the pay-TV cable service that supplied Netflix with films from Disney and Sony Pictures. The license expired in February and some believe the loss of those titles, as well as others, could impact subscriber additions. Netflix says the loss of the Starz deal hasn't affected subscriptions so far.

There's no hiding that the films in Netflix's streaming area aren't as fresh as in the past. So, what happens if there's less desirable content at Netflix? Doesn't that mean Hastings' virtuous cycle could get stuck in reverse? Fewer titles = fewer subscribers = less revenue...well, you get the picture. In that situation, the cycle turns into a maelstrom that sucks the service downward.

Meanwhile, Netflix's competitors are looking more formidable by the day. Even if you believe Hastings' assertions that Hulu and Amazon are much smaller and represent less of a threat to his business than the cable companies, that's hardly reason to celebrate. HBO launched its HBOGo streaming service for subscribers of the pay-TV service last year and that continues to grow. Now, Netflix is facing Comcast's new streaming service Xfinity Streampix.

Both HBOGo and Streampix require customers to pay for cable and that means Netflix is still far cheaper. The question is whether consumers will continue to find Netflix -- with the company's dated streaming-film catalog -- a better value.