That huge boost in Netflix’s (NFLX) share price Jan. 24 finally put the investment in positive territory for most shareholders, many of whom endured the heart-stopping 75% dive in its value in late 2011, as seen in a stock chart. So is this a sign of better days ahead, or just a great time to get off this roller coaster?
Netflix’s earnings report Jan. 23, which showed $0.13 earnings per share rather than the $0.13 loss analysts had forecast, led to several recommendation changes on the shares. For example: JPMorgan Chase (JPM) raised its recommendation to overweight from hold, Raymond James Financial (RJF) moved from underperform to market perform and earnings estimates went up all around. But Credit Suisse Group (CS), which had been a buyer, went the opposite direction with a hold recommendation in line with the vast majority of analysts that follow the shares. Several sell recommendations remain.
The divergent opinion center around a couple of facts highlighted in the earnings report. Netflix is adding streaming subscribers – some 2.1 million last quarter in the U.S. alone – at a faster rate than many thought possible. The consumer outrage over short-lived subscription changes back in 2011 appears to be forgotten, and Netflix remains the most popular supplier of movies and TV shows on earth.
On the flip side, the problems that have helped keep its share price at a quarter of early 2011 levels are still around. Namely: its costs are rising rapidly. Content providers like The Walt Disney Co. (DIS) and Viacom (VIA) are striking harder bargains for licensing agreements. Competitors like Amazon.com (AMZN), Google (GOOG) and a long list of smaller entities are willing to pay up for streaming rights too. Some content makers, like HBO, won’t sell anything to Netflix because putting their stuff on Netflix takes viewers away from their cable stations. Netflix is creating its own programming, but that has even higher up-front costs. CEO Reed Hastings warned that free cash flow would be “materially more negative” in the current quarter that the last, and then “improve substantially.”
On top of this remains about $3.1 billion in off-balance sheet obligations to pay for content that’s not yet delivered. There are capital expenditures necessary to keep streaming running smoothly too.
Netflix is getting through this crunch by raising its spending limits to 120% of P&L instead of 110%. International expansion has been put on hold until at least late this year. (The company is still losing money overseas.) The company also is hawking DVDs-by-mail again, which has slowed the decline of that business. Finally, Hastings said the company was considering borrowing more money, although he gave few details.
Hastings contends that the launches of several new Netflix-produced series on Feb. 1 “will be a defining moment in the development of Internet TV,” and one that will help the company add loyal subscribers. Netflix has produced new episodes of a popular British political drama, “House of Cards,” and a new thriller series called “Hemlock Grove,” for example. All episodes will go online at once, which allows for marathon viewing day or night of programs never seen anywhere else. It does make the tradition of eagerly gathering around the Telly at 9 p.m. on Thursdays for a favorite show seem horribly old fashioned.
But is this enough to make Netflix shares worth buying or holding now? It trades like a great growth stock; 183 times earnings, a laughable PE ratio, and a price to sales ratio of 2.3. Its only source of earnings is the unbound subscriber who pays $7.99 a month for the service. The company needs to constantly add subscribers in order to get cash to pay for the programming it needs to attract new subscribers. (Got that?) Right now, it isn’t getting enough of those new subscribers, even though it did a surprisingly good job of attracting them last quarter. Netflix doesn’t divulge content costs directly, but we know they are much higher than they’ve been in the past and will be higher again this year. Free cash flow is in negative territory and seems likely to stay there this year. Debt, possibly, will rise.
If you believe that Netflix can avoid any cash flow or debt issues that would alarm investors, holding on to your Netflix shares as a growth stock makes perfect sense. That belief requires confidence in Netflix’s ability to ramp up subscriptions quickly (perhaps there’s a new “Downton Abbey” in that line-up above?), and to hold down the prices they pay for content even as competitors bid them up. If that sounds like a big leap of faith given the available information, then well, you probably have some profits worth taking now.
Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at email@example.com.
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