Dropoff could drive content cost crunch

All eyes will be on Netflix’s subscriber tally when its first quarter earnings are announced Monday amid analyst concerns the crucial metric could see some softening.

The Los Gatos, Calif.-based company previously indicated this will be the first quarter in which its earnings will post a loss, estimated by analysts to be 27 cents per share. But the subscriber count is getting more attention than net income primarily because Netflix has already signaled that its international investments will prevent its profitability for the remainder of the year.

“The actual earnings will be far less relevant to the street than its sub growth,” said Janney Capital Markets analyst Tony Wible. “A lower sub estimate may lead bulls to question if we truly saw a recovery in 4Q11 and has the potential to erase the recent rebound in the stock.”

The first quarter is getting scrutinized given skepticism that the gains of the previous quarter could ultimately end up an anomaly, masking the damage Netflix did given a pair of disastrous decisions in the third quarter of 2011 regarding pricing and the structuring of its business that drove subscriber cancellations and wiped out the company’s market cap.

In the previous quarter, Netflix reported 24.4 million domestic subs and an additional 1.86 million internationally, for a total of 26.2 million. That represented a gain of 600,000 subs over the previous quarter–380,000 of which came from outside the U.S.–and 2.76 million cancellations among its domestic DVD subs.

Netflix itself has offered guidance of somewhere between 22.8-23.6 million domestic streaming subs at the end of Q1, with a boost of 1.5 million subs. The first quarter of 2012 will also be the first time Netflix reduces the transparency on some of its key metrics including churn rate.

Analysts have cited a number of factors that could drive down the subscriber tally from the mid-quarter removal of Disney titles that came under the now-expired Starz deal to the arrival of new competition including Comcast’s Streampix.

Given the absence of advertising or affiliate revenue, sub dollars are under immense pressure to singlehandedly cover the company’s fast-rising costs for streaming content. Off-balance-sheet cost commitments for Netflix content have been estimated at $3.9B at the end of 2011, up 200% the previous year.

“While rising digital content costs are not surprising given Netflix’s shift to a streaming-only company, we believe Netflix’s mounting off-balance sheet obligations add a greater level of risk to future earnings and liquidity in 2013 and beyond, which will have to be supported through continued subscriber growth,” wrote Barclays Equity Research analyst Anthony DiClemente.

The pessimism is partially fueled by traffic data to Netflix.com that analysts have always treated as a leading indicator of the subscriber base’s vitality. Comscore shows that traffic to the site is up 9% over the first quarter in 2011, while there was a 44% increase from the fourth quarter of 2010 and 2011. Search traffic for Netflix is also flat.

However, those calculations don’t take into account the growing number of Netflix subs who may be using the service entirely from a connected device as opposed to via Web browser.

J.P. Morgan analysts warned that the mild winter most of the U.S. experienced could also impact 1Q subscriber numbers. The weather has also been cited as a factor in softening TV ratings over the same period.

The first quarter of the year actually tends to be Netflix’s best judging from the past two years, when year-over-year subscriber growth rose 17% (2011) and 14% (2010).

Netflix stock closed Friday down less than 1%, to $106.11.

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