This Is Why Netflix Will Go Bankrupt
May 13 2013, 10:15 | about: NFLX
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in NFLX over the next 72 hours. (More...)
Netflix (NFLX) is a stock that proves that the market is not efficient. After reporting first quarter earnings on April 22, the shares jumped over 24 percent. So, were the first three months of 2013 really that good to justify the rise? If we examine what had actually happened, we see that the company added about three million new subscribers and beat earnings estimates by an incredible 13 cents! Now the stock is only trading at a conservative 500 times trailing earnings.
It really does not take a genius to realize that Netflix is overvalued. But what most investors fail to understand is that things are much worse than they appear. Netflix did beat GAAP earnings; I think we can all agree on that. But are these real earnings? To the true investor it is cash that matters and this is something Netflix is lacking. During the last few years free cash flow has deteriorated significantly from a high of $183 million in 2011 to a negative $113 million during the last twelve months. This should be a huge red flag! Since Netflix is not cash flow positive anymore, the company has been forced to take on more debt in order to be able to continue purchasing new content.
In this article I will prove that even raising subscription prices and continuing to capture more market-share will not help Netflix over the long run. I will also talk about the company's billions in "off-balance sheet" liabilities that most investors do not even know exist. Finally, I will attempt to show why Netflix is a bubble stock that will eventually burst.
Profitability is an Illusion
It drives me crazy whenever I hear someone say that Netflix is profitable. Anybody who has ever taken a basic accounting course knows that reported net income (as required by GAAP) is not true profit. There are countless examples of companies reporting huge "accounting profits" and end up still going bankrupt. It is free cash flow that matters and this is what I will mostly focus on.