Tomorrow morning, I will publish my overall take on the state of Netflix (NASDAQ:NFLX) the company and NFLX the stock. Here's a preview:
The stock is headed to $300.
Today, however, I wanted to focus on the analyst reaction to the company's Q4 earnings report.
Alongside Seeking Alpha, the Wall Street Journal does the absolute best job of putting all of the key market news in one place, both in print and online. My WSJ subscription equals money well spent, especially because I have so many choices for consumption - black and white, computer, Kindle Fire.
The Journal reviewed some of the analyst reaction to Netflix's Q4 earnings beat. As usual, the Journal proved that it's not Tiernan Ray by issuing a level-headed piece that listed some notes that emanated from the street last night and this morning.
The Journal did not include comments from Wedbush's Michael Pachter and Janney's Tony Wible. I emailed with both men last night.
In summary, Pachter helped me make sense of Netflix's subscriber number totals (I get deeper into this in tomorrow's article), noting that 2.1 million people "traded down." That's a considerable revenue hit. Pachter also thinks Netflix is dreaming and being "disingenuous" by implying that its streaming content is "fungible." He argues that when Starz (LCMA) movies leave, considerable numbers of subscribers will as well.
As for Wible, he called Netflix's cash flow statement "interesting" (to say the least) and pointed out something else I discuss in tomorrow's article, virtually all of the subscriber upside came from free trial customers.
Meantime, referring to NFLX's spike as a dead-cat bounce, the Journal's Steven Russolillo highlighted the following note from Pacific Crest:
We remain positive on Netflix's consumer value proposition and its competitive advantages. However, increased confidence in the company's long-term subscriber and margin-expansion potential are necessary for us to become more positive on the stock, particularly in light of the likelihood for increased domestic competition from Amazon.
Amazon.com (NASDAQ:AMZN) brings up an interesting situation. I've never been one to argue that competition will, in and of itself, crush Netflix. Apple (NASDAQ:AAPL), for example, has plenty of competition, but it simply does not matter. To a company as well-managed and with as sound a business model and product pipeline as Apple, the competition exists as a non-factor. If Netflix operated from anything resembling a position of strength, it would not bother me that Amazon and others are nipping at its heels.
That said, on Netflix's call yesterday, the notion of Amazon opening up its instant video offering to non-Prime members at a lower price than Netflix charges simply cannot be ignored. Netflix bulls cannot seem to get a couple of things through their heads:
- It is not a law of the universe that posts, if streaming is the future then Netflix must be leading part of it.
- Yes, streaming is as much of a money-losing proposition to Amazon (and others) as it is to Netflix, but Amazon (and some others) can afford to use loss leaders to drive the core areas of its larger business. Netflix cannot do this because it (A) has no larger business and (B) is killing what has been and could continue to be its larger business - DVD.
In the Journal article, Canaccord Genuity and Morgan Stanley follow up on the competition angle, expressing concern. Each flatly states or implies that profitability will not be an easy task for streamers on streaming alone. Back to Pachter with what he had to say about the intersection of streaming, content costs and profitability in the note he put out today and sent me via email:
Netflix management stated during the live question and answer session that they believed their streaming content costs were fixed, and that marginal streaming subscribers contributed virtually 100% operating profits. We find this statement to be either misinformed, naïve or disingenuous. While we don't think that management is stupid or evil, we are baffled that they can be so naïve. It is clear that content owners seek the market value of their content in licensing deals; if demand goes up for the content (as measured by overall usage), it logically follows that rational content owners will seek ever-increasing license fees. Netflix management appears to believe that because they are often the only bidder for content, they are in a position to dictate market value, and they appear to further believe that all content is fungible. We completely disagree with this notion.
So very-well stated. I completely agree (with Pachter).
After reading Pachter, it's next to impossible not to agree. Sadly, we run in a market where logic does not prevail in relation to Netflix. And, after reading Pachter, it's tough not to laugh at the typically very strong Mark Maheny at Citigroup. Here's the blurb the Journal reprinted from his bullish note on NFLX:
1) Q1 Guide for approx. 1.5 to 1.7MM Domestic Streaming Net Adds is consistent with Q2:11 pre-apocalypse Net Adds of 1.8MM - suggests NFLX's Streaming segment is back to growth; 2) Q4 Domestic Streaming Contribution Margin of 11% (vs. 8% est) and reaffirmed Guide for Margin expansion addresses some Streaming profitability concerns; 3) Q4 International Contribution Loss at low end of Guide range with peak Q1 loss of $110MMish suggests control over International investments; 4) Our Q4 Proprietary Survey work established at-least stabilization in NFLX customer satisfaction with no competitive erosion.
Wow. So, streaming is back to "growth." Mark might want to have a closer look at the numbers. I gave away about 10 copies of my options eBook yesterday, but sold only five; I guess my book sales are "back to growth." On the basis of points 2, 3 or 4, you could make the case that Netflix survives and ambles along, but I am not sure how you can justify a "buy" rating on the stock of a company that:
- Cannot tell you when it might be profitable again;
- Claims it raised $400M and diluted the stock just to have cash in the bank it does not intend use;
- and says, back in July that it wants to keep DVD "as healthy as possible" and return to marketing it in Q4, only punk-slap the profitable segment on Wednesday's call, noting that it will, all of a sudden, not market it in 2012.
Nothing short of flabbergasting. I always thought "the market" put its big money behind companies with management teams it can be confident in. You know, like it does with Amazon.com. Netflix's performance yesterday inspired nothing even close to confidence.
That said, as long as irrationality reigns, get ready for another epic bull run in 2012.
Disclosure: I am short NFLX.
Additional disclosure: I own NFLX June $40 put options. I am going down with the ship. That was the plan all along in a departure from discipline.