Another reason for Netflix (NFLX) to hurry up and transition to a purely digital model: A potential postal rate change could cut the company’s operating income per subscriber by two-thirds, say Citi analysts Mark Mahaney and Tony Wible.
The problem is apparently Netflix’s return mailers, which jam automatic mail sorters and cost the Postal Service millions in manual sorting costs. To address this problem, the Postal Service is considering jacking rates, which Mahaney and Wible argue would hurt Netflix more than Blockbuster.
The analysts believe Netflix would respond by redesigning its mailers. This said, they still hate Netflix’s stock and love Blockbuster’s (BBI). Their specific thoughts after jump:
Citi’s Mahaney and Wible:
An audit prepared by the Postal Service Office of the Inspector General (OIG) has concluded that the soft leading edge on 70% of NFLX’s return mailers…get stuck during sorting and require manual processing and added about $21 mil in annual labour costs.
To combat [this], the OIG has recommended imposing a 17 cent surcharge on each mailer. If NFLX has to bear the full brunt of this increase(without other cost offsets), monthly operating income per paying subscriber would fall 67% from $1.05 to $0.35. NFLX questions whether the USPS will accept the OIG’s suggestions, and if no hikes occur, the impact would be limited.
Given the magnitude of this risk, we believe NFLX will work towards resolving this issue by redesigning its mailers. If the USPS forges ahead with a rate increase, NFLX has more exposure to the change and is less able than BBI to offset any increases with cost savings. A price hike would exacerbate the risks we see in NFLX’s business model as aggressive pricing, maturity concerns, and higher costs prevail. We reit Sell rating and $18.50 TP.
Reiterate Buy on BBI – We have confirmed that BBI’s mailers are not prone to the
same issues. Our Buy rating and $8 target price is based on 1)improving
title line-up; 2) gaining share from the MOVI bankruptcy; 3) simplifying
in-store pricing; 4) deploying kiosks; and 5) improving retail strategy.