Netflix Horror Show: The Real Reason Shares Plunged 17%

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Gareth Cattermole / Getty Images for Netflix

As a purely financial matter, Netflix’s quarterly report should not have precipitated the absolute shellacking that the company’s stock suffered after-hours Monday, wiping out about $1 billion in shareholder equity. The company’s loss wasn’t as bad as Wall Street expected, and while its second quarter projections were light, they were only just so. That’s why I think Netflix’s 16% after-hours swoon is really being driven by emotional factors, as increasingly nervous shareholders seem to be losing patience with the company’s stalling growth and rocky transition from DVD rentals to video streaming.

Netflix already tested investor patience last year, after a series of missteps alienated many customers. Last summer, the company ignited outrage after raising prices by 60% on customers who subscribed to the joint DVD-by-mail and online streaming package. Then, the company was forced to scrap plans to rename its DVD service Quikster and spin it off, after customers freaked out. Taken together, those incidents — which reflected management’s under-appreciation of the importance of the DVD business — caused many customers to flee, taking a bite out of the company’s subscriber growth, which had driven its share price skyward.

“We’re feeling good about the progress we have made, but are conscious of the fact that it’s tender and that we have to be extremely diligent and thoughtful as we build back up our brand reputation,” CEO Reed Hastings Hastings told analysts in comments cited by MarketWatch.

(More: Netflix CEO Takes Swing at Comcast Xfinity over Net Neutrality)

On Monday, the company announced a $5 million first-quarter loss — not as bad as analysts had been expecting — on overall sales that declined slightly from $876 million last quarter to $870 million. Although the company added nearly 3 million new streaming subscribers, it lost over 1 million DVD subscribers. The DVD business generated over twice the profit as streaming in the first quarter.

Neflix said it expects sales of $873 million to $895 million next quarter, just below Wall Street estimates of $897 million, and profit that could range from a loss of $6 million to a profit of $8 million. Overall this year, the company said it expects to add 7 million new streaming subscribers — roughly the same amount as 2010 — not exactly robust growth. Even worse, in the next quarter — and this clearly spooked investors — the company said it will add fewer new subscribers than it did during the same period in 2010.

“They are giving a signal to the Street that their growth story is over,” Wedbush Securities analyst Michael Pachter, who rates Netflix a “sell,” told Reuters. Netflix shares, which have traded as high as $300, plunged from about $102 to $85 in after-hours trading.

Although Netflix was an early pioneer in online movie streaming, the company faces increasing competition, from powerful incumbent players, content companies and Internet rivals like Comcast, Verizon, Blockbuster/Dish Network, HBO and Amazon. The company also faces increasing content costs, which explains why it’s venturing into new programming with shows like Lilyhammer, but it has yet to score a homegrown hit. Still, the company sought to allay investor fears. “We see nothing new or particularly concerning this quarter to date in our member viewing, acquisition and retention,” CEO Reed Hastings and CFO David Wells said in a letter to shareholders. “All are healthy.”

Clearly, not all investors share that view.

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