By Jake Mann
Netflix, Inc. (NFLX), Netflix, Netflix. Chances are, if you've been anywhere near the financial blogosphere in the past week, you've heard incessant chatter about the streaming content company's epic appreciation. Since trouncing Wall Street's earnings estimates last Wednesday, the stock is up almost 57%.
To avoid needless repetition, here's a recap of Netflix's stellar earnings, but for most readers, there's an obvious question gnawing away at their investment subconscious: what do I do now?
At the moment, investors are in one of the following two scenarios. The lucky - or should we say prophetic - ones bought in before the intense escalation, and are undoubtedly pondering if they should be taking their profits. The other, less oracular group, meanwhile, did not catch a piece of the upsurge, but are likely goaded by headlines like "Can Netflix Reach $300 Again?"
While we are not going to sit here and proclaim what direction each individual market participant should take at the moment, we can help make the decision process a bit easier. See, while most armchair analyses have focused on the rudimentary, regurgitated metrics, we're going to take a run through some of the lesser-known facts about this situation. Let's get started.
1) Updated EPS estimates were much closer to reality.
This is a point that was originally made by Albert Fried & Company's Rich Tullo on CNBC last week, but it's an argument that has been fantastically under-reported after the fact. While Netflix appears to have outpaced the Street's earnings estimates by a whopping 26 cents per share in Q4 ($0.13 in actual EPS versus consensus of -$0.13), it appears that this beat may have been skewed.
More specifically, Tullo mentions " the average [Q4] estimate was 90 days old" adding "we initiated coverage with an estimate for this quarter of […] 11 cents." In fact, analysts' average EPS forecast for the following quarter has more than quadrupled in absolute terms over the past 60 days, according to data from MSN Money.
Now, this phenomenon is no secret, but it is often lost in the shuffle of today's world of rough-and-tumble journalism, so to speak. Keeping this in mind, a Q4 EPS beat in the range of 15-20% is closer to reality, and should be added as an asterisk to any further analyses.
2) Carl Icahn and Netflix execs are still having meaningful conversations.
Last fall, the infamous corporate raider Carl Icahn had reported a stake in Netflix just below 10% (see our full recap here). Between the date that news of Icahn's position broke and one day before Netflix's Q4 blowout, shares of the company had already risen more than 48%. In dollar terms, the stock's price had vaulted out of the high $60 range to surpass the $100 mark. Post-beat, the stock now trades above $160 a share.
So what can investors take away from this information?
Mr. Market's positive reaction to Icahn's involvement in the company indicates that a buyout - we won't speculate on the potential players - was viewed as a saving grace for Netflix shareholders. Reed Hastings and the rest of management's adoption of a specialized "poison pill" to ward off a hostile takeover was initially viewed as a long-term negative by some analysts, but the stock's recent performance indicates that at least some level of independence can also stimulate value-creation.
Interestingly, Hastings indicated in a letter to shareholders last week that he and Icahn were still having "constructive" discussions about the company's future, but no specifics were given. This simple disclosure given by the Netflix CEO should be taken as a positive, as any efforts to further stoke the stock's recent gains would be welcome, even if an outright merger or buyout isn't in the cards.
While another attempt at a Qwikster-like split would be ill advised, at least one analyst thinks a spin-off of Netflix's international business wouldn't be a bad idea. We'll have to wait and see if Icahn can work any of his "magic" going forward.
3) Netflix's content supremacy doesn't just lie in the sheer numbers.
On Insider Monkey, we discussed how the size of Netflix's library dwarfs the likes of Amazon.com (AMZN) Prime, Hulu Plus, and Coinstar's (CSTR) Redbox service. According to the company's latest shareholder letter, of the 200 most popular titles in its library, Amazon, Hulu Plus and Redbox offer a little more than half the top-tier content that Netflix does, combined.
In addition to this advantage, which is partially driven by deals with Disney and Universal (international-only), Netflix is seeking to offer its viewers homegrown, high-quality content. Building off the success of its Lilyhammer original series last year, Netflix plans to release a new season of Arrested Development and House of Cards' first season in the coming months. Cards is one of the most anticipated dramas of 2013, and exclusive broadcasting rights will likely boost subscribership over the next few months.
The show's $100 million price tag indicates that Netflix is serious about this endeavor, and Reed Hastings' allusions to a coming battle with Time Warner (TWX)-owned HBO spell out the company's motives quite clearly.
Perhaps equally as important is Netflix's massive data trove. In the past, the company's system has given it the ability to accurately determine which third-party content maximizes viewership. Already an advantage over its traditional TV-based peers, Netflix's new focus on original programming makes even better use of this information, allowing it to decide which actors and themes are most likely to succeed at any given time. Better yet, this information is inherently localized to Netflix's entire audience base.
In an interview last week, the company's content head Ted Sarandos periphrastically indicated "there's a large audience for [David] Fincher, [Kevin] Spacey and political thrillers" when asked about the development of Cards. We originally covered Sarandos' role with Netflix earlier last year, and it's rumored that he's looking to develop 4-5 original shows annually. With advanced user metrics at his fingertips, Sarandos can steer Netflix's in-house programming in the right direction for years to come.
4) It's all about the right kind of recurring revenues.
As Tien Tzuo's piece on AllThingsD so brilliantly discussed late last year, most investors are improperly valuing subscription-based businesses. Tzuo says that ratios like EPS "are essentially worthless metrics." In our opinion, this applies more to long-term uses of the ratio, rather than short-term comparisons between analysts' estimates, as described in point No. 1.
Keeping this in mind, it's important to note that the entirety of Netflix's revenues are essentially recurring, because they are subscription-based. Still, logically speaking, investors should prefer that the company's streaming subscription revenue base is growing faster than its DVD business.
As indicated in the company's investor letter, streaming revenue now makes up a little over 73% of Netflix's total top line, much larger than the 57% figure the company reported one year earlier. Over this same time, total revenue grew by nearly 8%. Thus, this indicates that Netflix is building its future on the right kind of recurring revenue, and the stock's growth-oriented bullish thesis remains very intact.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.