Netflix

Thesis: (Please see the Details section for explanations of each bullet point below)
• Expectations on Wall Street are extremely high, as Netflix gave up 20% following days after its 1Q earnings update.  
• With high 2Q expectations, investors may be disappointed again with lower gross margins and a higher churn rate than expected.   To add to this, competition is finally picking up with Blockbuster and Walmart entering the market.
• On the side, short interest has increased and insiders have begun selling their shares.
• Lastly, investors may be missing the large picture of Netflix's true market potential in the long run.

Background:
• Launched in 1998, Netflix is the world's largest online movie retail service.  
• For a set monthly fee of $21.99, subscribers can rent as many DVDs as they want, with three movies out at a time and keep them for as long as they like.
• The company now operates 24 shipping centers in the United States and can reach 80% of its customers with 1 day delivery.
• The company grew revenues by 80% to $100.8 million in 1Q, and has 1.932 million subscribers and 760,000 new trial subscribers, an increase of 82% year-over-year.

Details:
• Expectations on Wall Street are extremely high as evidenced by the 80% STRONG BUY/BUY ratings. (10% HOLD, 20% STRONG SELL)
o Stock fell over 20% following days after 1Q earnings update.
 Company reported larger 1Q loss (11 cents a share) and gross margin 43.6% in low end of guidance.
 Company blames falling margins on increased movie rentals per average paying customer.   Netflix thus reacted by raising prices from $19.99 to $21.99 (effective June 15)
o 2Q Expectations are also set very optimistic
 Analysts have forecast a profit of 16 cents a share in the second quarter and 50 cents a share in the full year.   Wall Street analysts, on average, forecast earnings per share growing 86% in 2004 and 161% in 2005.
 Netflix expects to earn $1 million to $3.5... [continues]

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