Netflix shares fall as sales growth fails to impress investors

Wall Street’s sky-high expectations for Netflix Inc. sent its stock swooning in after-hours trading Wednesday as the fast-growing DVD-by-mail company failed to meet second-quarter revenue expectations.

Netflix’s stock was down 9% after the market closed after it reported $520 million in revenue for the three months that ended June 30. That was up 27% from the same period a year earlier but on the low end of guidance the company had provided to analysts.

The sharp drop in Netflix’s stock price reflects just how big hopes for growth have become among investors. The company reported a 34% rise in net income to $43.5 million and added 1 million subscribers, nearly 4 times as many as it added in the same quarter last year. Both figures were slightly above Netflix’s guidance.

The fact that Netflix added more subscribers, but not more revenue, than expected may indicate that many new subscribers are opting for the company’s lowest-priced subscription plans, which start at $9 a month.

The continued growth of Netflix and the $1-a-night DVD kiosk company Redbox comes as DVD sales have been declining for nearly two years, though an industry group recently reported that the rate of decline shrank significantly during the second quarter, thanks in large part to the DVD release of the hit film “Avatar.”

In comments accompanying the earnings report, Netflix Chief Executive Reed Hastings said that investing profit into acquiring content for the company’s Internet streaming service is a top priority.

In a small but groundbreaking deal sealed this month, Netflix bought exclusive rights to films from Relativity Media for its Internet service during the time period when movies usually run on pay cable. The deal put Netflix into direct competition with channels such as HBO and Showtime, a position Hastings cheered.

“Exclusives ... are a core part of the pay-TV market into which we are growing,” he said. “At this point we can start to afford some major TV shows and movies on an exclusive basis and plan going forward on a mix of more-expensive content and lower-cost non-exclusive content.”

Hastings also said that television shows were an important draw for Netflix’s online streaming service. However, TV streaming puts the company into direct competition with Hulu’s new premium subscription service.

“The Hulu team is sharp and we’re not going to underestimate them,” Hastings said.

Last quarter, a record 61% of Netflix subscribers watched a movie or TV show online, up from 37% a year earlier and up 55% from the first quarter of 2010.

At the same time, Netflix shipped fewer discs to subscribers than it expected and invested some of the money it saved on postage into marketing. Going forward, however, Hastings said the company would spend those types of savings on licensing more movies and TV shows for the Internet.

“If we find enough content deals where the terms make sense to us, we’ll be spending lots more on streaming content,” he said. “Otherwise, we can spend more on marketing.”

Based on the second quarter’s strong growth, Netflix substantially increased the number of subscribers it expects to have at the end of the year to 17.7 million to 18.5 million from the 16.5 million to 17.3 million it predicted three months ago. It also slightly increased net income guidance to $141 million to $156 million.

By the end of the year, Hastings said, he expects the rapid growth Netflix is enjoying to wane.

“This kind of rapid acceleration is unlikely to continue for long.”

Netflix shares fell 74 cents to $119.65 before last quarter’s financial performance was announced.

ben.fritz@latimes.com