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For the record, I am a buyer of Netflix (NASDAQ:NFLX) products but I will never be a buyer of any stock near Netflix's current valuation. Shares shot up even higher Tuesday (24%) after posting a 1st quarter $0.05 EPS or net income of $3 million. This would probably be a good result if the company had a market cap of $200-$500 million but as of today it is worth $12.19 billion... Oh I'm sorry, Non-GAAP net income was $18.6 million or $0.31 per share diluted, we will go with that, who needs GAAP anyway.

So as not to confuse anyone with where I stand, I will only be highlighting a few warning signs that investors should take into consideration before buying any shares of Netflix, they are as follows:

On Debt and Capital Strength

From the Earnings Call

Erin Kasenchak - Director, IR

Great. Let's look at a few questions on financials. Could the company please quantify its off balance sheet content liability, specifically interested in those the total amount of obligation is outstanding, as well as the amount currently outstanding that is not on the balance sheet.

Reed Hastings - Chief Executive Officer

So I'll answer this in total to because usually how we get this question. We had $5.6 billion liability -- $5.6 billion in commitment as of the end of December. That moved to $5.7 billion in commitments as of the end of March, $2.4 billion being part of liabilities on the balance sheet and $3.3 bill not on the balance sheet.

Erin Kasenchak - Director, IR

Great. Do you believe the company can fund it's liabilities without an additional debt raise. Would you consider raising capital given the low-rate environment?

Reed Hastings - Chief Executive Officer

Well, we just did raise capitals. So yeah, we would consider it. And I would say that we are fine on capital at this point.

So, debt is up $100 million in total and $3.3 billion is not on the balance sheet. But don't worry, they will just raise more capital.

Why not distinguish the debt with free cash flows you may ask?

Maybe because free cash flow was negative $42 million! But again, don't worry, that was better than management expected (winning).

On Management's Inability to Make Profitable Acquisitions

Also from the earnings call

Erin Kasenchak - Director, IR

Great. You had anticipated that free cash flow in the quarter would be more negative than the prior quarter. And it ended up more favorable than the prior quarter. You acquired less than $600 million of streaming content this quarter less than your quarterly run rate last year despite the payment for House Of Cards. For any content acquisitions deferred to the June quarter, is this a good run rate for content acquisition or was it a low quarter?

Reed Hastings - Chief Executive Officer

So no content payments were deferred. I would say that we anticipated a bunch of small items stocking on each other in the first quarter that didn't happen. So we'll be less lumpy than we previously anticipated. And then the second part of that question was…

Erin Kasenchak - Director, IR

Is this a good run-rate for content acquisitions?

Reed Hastings - Chief Executive Officer

I'm not sure how to answer a good run rate on content acquisition. I would say that we continue to expand our content. And you'll see that expansion has declined over the last year and two years. So the rate of expansion has started to slow but we'll continue to invest in content.

I think this pretty much sums up management's focus on acquiring subscribers and content despite profitability. How can investors expect any value to be added when management doesn't even seem to know how to evaluate their acquisitions? Does that make them all good business decisions?

On More Positive Earning Reports

From the Investor Letter

Going forward we'll continue to provide our full DVD segment level reporting but will only provide guidance on DVD contribution profit since that is what we focus on.

At least management is consistent in pushing its membership count growth. Domestic DVD was the only segment experiencing a membership decline despite its $113 million contribution to profits. That's the only thing that really matters anyways. Thank you in advance management for going ahead and removing those other details, that will save us all a lot of time!

Bottom Line

  • P/E of 555.6
  • On the balance sheet D/E of 0.5

Netflix sure does look pretty up there but I'm afraid its due for a harsh landing once management needs to start funding more of its debt with capital infusions. I'm not so sure what investors see that is so fundamentally good about the company but I would suggest for all of them to start worrying when management casually announces off-book liabilities and doesn't seem to have or care about a way to analyze the profitability of content acquisitions... their main product.

Source: Is Netflix The Next Enron?