Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message|
( followers)  

Investors in Netflix (NASDAQ:NFLX) have yet another reason to party after the company announced its third quarter results.

Shares are close to breaking the $400 mark towards the upside following the earnings report. After the insane momentum so far this year, and late into 2012, I have no intentions to initiate any long or short position at this point in time.

Third Quarter Results

Netflix generated third quarter revenues of $1.11 billion, up 22.2% on the year before, and roughly in line with consensus estimates of $1.10 billion.

Operating income more than tripled compared to last year, coming in at $57 million. Net income four-folded to $32 million, with diluted earnings per share coming in at $0.52 per share. Consensus estimates for earnings stood at $0.48 per share.

Looking Into The Results

The domestic operations of Netflix net added 1.29 members during the quarter, ending the quarter with 31.09 million members. Revenues rose by 26.1% to $701 million, while contribution profits rose by 72.9% to $166 million. Contribution margins rose by 650 basis points to 23.7% of total revenues.

Domestic operations saw a boost from the buzz generated surrounding "Orange is the new black" and the Emmy nominations during the quarter. Netflix furthermore launched new seasons of "The new girl", "The walking dead" and "Breaking Bad", among others.

The international activities net added 1.44 million members, more than double the net additions in the second quarter of this year, and the third quarter last year. The international activities now have 9.19 million members which generated revenues of $183 million compared to just $78 million last year. At the same time, contribution losses narrowed from $92 million to $74 million, as contribution margins improved to negative 40.6%.

Growth in the international division was driven by expansion in the Nordics as well as the Netherlands.

Fourth Quarter Guidance

Netflix is quite upbeat for the fourth quarter. Domestic net additions are seen around 2.0 million members, as contribution margins will fall a little bit compared to the third quarter. International net additions are seen around 1.3 million members, down a bit from the third quarter. Given that the costs related to the Dutch launch are gone, contribution margins are expected to improve further.

Revenues from streaming operations are seen at $953 million, up from $700 million last year, and up $884 million from the third quarter. Netflix guides for net earnings of $37 million, with diluted earnings per share seen at $0.60 per share. Actually, Netflix guided for fourth quarter earnings between $0.47 and $0.73 per share, versus consensus estimates of $0.46 per share.

Note that the numbers provided above, reflect the midpoint of the guided range by Netflix.

Valuation

Netflix ended the third quarter with $1.13 billion in cash, equivalents and short term investments. Total debt stands at $500 million, for a net cash position of around $630 million.

For the first nine months of the year, Netflix generated revenues of $3.20 billion, up 20.0% on the year before. The company reported a $64.0 million profit compared to earnings of $9.3 million a year earlier. Full year revenues are seen around $4.4 billion, as net earnings could come in around $100 million.

Factoring in gains of 11% in after-hours trading, with shares exchanging hands at $395 per share, the market values Netflix at $23 billion.

This values operating assets of the firm at $22.4 billion, or roughly 5.1 times annual revenues. Shares trade around 200 times GAAP earnings.

Netflix does not pay a dividend at the moment.

Some Historical Perspective

Shares of Netflix have risen from $50 in 2009 to a well-documented peak around $300 in 2011. Shares fell back towards $50 by the end of 2012 to recover to levels approaching the $400 mark in after-hours trading.

Between 2009 and 2012, Netflix increased its annual revenues by a cumulative 116% to $3.61 billion. The company reported a $116 million profit in 2009, which fell to just $17 million in 2012.

Note that both revenues and earnings are set to increase markedly in 2013.

Investment Thesis

So it seems that Netflix had a decent quarter, both domestic as well as internationally. Netflix ended the quarter with over 40 million members, up by more than 10 million on the year before. This on the back of the launch of new original shows and the continued international expansion.

That being said, CEO Hastings remains cautious. The real number to focus on according to him is the 114 million subscriber basis of HBO, indicating Netflix still has a long way to go. Netflix' strategy to develop own shows is paying off. It is creating premium content available for its own subscription service, which is quite a bolt move. Yet highly successful shows like "House of Cards", and "Orange Is The New Black", are pushing viewers to Netflix.

As a warning, Hastings attributed the enormous stock rise so far this year to investors "euphoria", as Netflix still has a long way to go before out-competing HBO. That being said, the growth story in terms of subscription growth remains intact, especially in overseas markets.

The next phase of growth should come from increased penetration, by collaborating with traditional cable-TV networks. The company already closed deals in Sweden and the UK, but Netflix aims to close a deal with Comcast (NASDAQ:CMCSA) to offer its services through cable set-top boxes. Under such a scenario, Hastings sees the potential for 60 to 90 million streaming members in the US over time, and Hasting is willing to boost content spending even more, notably on original content production.

Back in July of 2012, I last took a look at the prospects for Netflix. I concluded that investors might see an interesting long term entry point, with shares trading just around $60 at the time.

I concluded that Netflix is trying to push forward as quick as it can given the limited resources it has. Note that according to Hastings, the biggest competitors are financially stronger cable companies which could invade in its market. That being said, Netflix is trying to create a global market and brand, with domestic operations still financing the international expansion.

Interestingly enough I was one of the few to pick up some shares at the time, only to sell them out later in 2012 at a modest profit, but below $100 per share. I could not have possibly imagined Netflix trading around $400 per share a year later. Given that Hasting is warnings for euphoria and is contemplating raising capital to finance content creation, I remain a bit cautious after runaway momentum.

That being said, Netflix is no easy short as momentum could push shares anywhere in the near term. Bearish articles have appeared around $100, $200 and $300 per share already earlier this year.I have no position now, and would not initiate any position at all at current levels.

Source: Netflix - Shares Are Entering 'Euphoria' Phase