Netflix, which is based in Los Gatos, Calif., says it is losing subscribers… (Justin Sullivan, Getty…)
Long the entertainment industry's biggest success story and a darling on Wall Street, Netflix Inc. is suddenly losing subscribers and stock market value in the wake of its controversial price hike.
Shares in the online video and DVD rental company plummeted nearly 19% on Thursday after Netflix disclosed that rather than adding 400,000 subscribers in the current quarter, which ends Sept. 30, it is poised to lose 600,000. That would leave it with 24 million users in the U.S. instead of the 25 million the company previously told investors to expect.
The surprise development marks a significant miscalculation by Netflix about how consumers would react to the change in pricing it announced in July that increased many people's monthly bills.
Asked to address the issue at a news conference Thursday, Netflix's chief content officer, Ted Sarandos, acknowledged that the Los Gatos, Calif., company had underestimated the new policy's effect on its customers.
"Being able to precisely forecast and predict the behavior of that many people on a fairly radical change is something we'll get better at," Sarandos said.
It's the first time in years that the high-flying company has disappointed investors so dramatically. Although Chief Executive Reed Hastings said in a public letter that revenue and earnings for the quarter would not be affected by the subscriber losses, investors took the news as a sign that Netflix's seemingly unstoppable momentum may be slowing.
"There is a lot of expected growth built into the stock price, and clearly that growth rate has been called into question because of the latest news," said Michael Corty, an analyst at Morningstar.
In the first seven months of the year Netflix stock skyrocketed 70% to a high of just under $300 in July. On Thursday it fell $39.46, or 18.9%, to $169.25.
Thursday's announcement was the second development this month that sent Netflix's shares tumbling. Two weeks ago, its stock dropped 9% after pay cable channel Starz said it would not renew an agreement that expires Feb. 28 allowing Netflix to stream movies from Walt Disney Studios and Sony Pictures.
Under its new pricing policy that took effect Sept. 1, Netflix split up its Internet streaming and DVD-by-mail offerings into two plans, each of which costs at least $7.99 a month. That works out to a price increase of as much as 60% for customers who use both delivery methods.
Netflix made the change to reduce its DVD mailing costs and generate more revenue to buy digital rights to movies and television programs from Hollywood studios.
In Thursday's letter, Hastings said most of the company's losses came on the DVD side. Netflix projected that it would have 3 million DVD-only subscribers at the end of the third quarter, but now says it expects 2.2 million. Its estimate for streaming-only customers fell slightly to 9.8 million from 10 million. The company still expects 12 million people to pay for both services.
Analysts who follow Netflix were divided on whether management's miscalculation was the first sign of an ongoing consumer defection or merely a bump in the road. Tony Wible, an analyst at Janney Capital Markets, said Thursday's development was unambiguously bad news for the company.
"Netflix had a test of whether it could push people from hybrid plans to streaming-only, but people said, 'Actually, we're leaving,'" he said.
Others were less bothered by the news.
"We believe the pricing changes appear to be having the intended effect, lowering the use of DVD plans, but the reduction is happening faster than expected," Piper Jaffrey analyst Michael Olson wrote.
A major challenge for Netflix in attracting people to its streaming video offering is a shortage of content, as it doesn't have digital rights to many movies available on DVD. The problem will only be exacerbated at the end of its Starz contract.
Meanwhile, potential competitors such as Amazon.com Inc. and Dish Network-owned Blockbuster Inc. are building out similar subscription video services.
At Thursday's news conference in Beverly Hills, Sarandos noted that movies are becoming less important to Netflix as reruns of television programs now make up the majority of content watched via streaming.
He also stressed the company's growing international business, which launched in Canada a year ago and is already close to profitability with 1 million customers in the country. This month Netflix debuted throughout Latin America and, according to people briefed on the matter who were not authorized to speak publicly, it is preparing to go into Britain and Spain in 2012.