Citigroup Analyst Cites Concern About Netflix Mailers

The possibility of U.S. Postal Service surcharges on DVD mailers caused one analyst to reiterate his "sell" rating on online video rental company Netflix, which ships over 1.6 million DVDs per day.

Citigroup analyst Tony Wible cited concerns about a potential U.S. Postal Service surcharge of 17 cents per mailer he said was proposed in a recent audit by the Postal Service.

An audit prepared by the Postal Service Office of Inspector General (OIG) has concluded that the soft leading edge on 70 percent of one DVD rental company's return mailers "get stuck during sorting and require manual processing and added about $21 million in annual labor costs," Wible wrote in a note issued Dec 4.

Netflix is not specifically mentioned, but is implied, he said.

A Netflix spokesman said he did not expect the company to have to pay extra postage costs.

In the audit report published in November and obtained on the Web site of the Office of Inspector General, the agency estimated the additional labor costs to process DVD mailers were $41.9 million during the past two years, and will be $61.5 million over the next two years.

"...employees manually process approximately 70 percent of the approved First-Class two-way DVD return mailpieces from one DVD rental company because these mailpieces sustain damage, jam equipment and cause missorts during automated processing," the audit report said.

A spokeswoman for the Office of Inspector General declined further comment beyond the report, which did not name the company, but recommended imposing the 17 cent surcharge on each mailer if the issue was not resolved.

Wible noted that if Netflix had to bear the full brunt of this hike, its monthly operating income per paying subscriber would fall 67 percent from $1.05 to 35 cents.

Netflix spokesman Steve Swasey said it was highly unlikely the company would have to pay any such assessments.

"We're in full compliance with U.S. Postal Service regulations and specifications," he said, noting further that if these regulations or specifications were to change, Netflix would change its mailer.

"We've already gone through 40 to 50 iterations of the mailer since Netflix started shipping DVDs a decade ago," he said.

In the same note, Wible reiterated his buy on Blockbuster , saying the Netflix rival's return mailing envelopes did not cause this problem and that the issue could make a big competitive difference for the companies.

Swasey said that Netflix actually saves the Postal Service about $100 million a year by picking up the returns from the post office.

Netflix shares closed down 3 cents Thursday to $23.90 a share on Nasdaq, while Blockbuster shares closed down 6 cents, or nearly 2 percent, to $3.12 a share on the New York Stock Exchange.