On Thursday, Netflix (NFLX) released fourth quarter earnings of $875.6 million in revenue and earnings per share of $.73. Though these numbers blew past analyst expectations, they would be viewed as extremely weak only a year ago. The stock increased 22% on the news. In the fourth quarter of 2010, NFLX reported earnings of $.86 per share. The earnings only tell part of the story. NFLX reportedly added 225,000 members, which exceeded the low-bar set by analysts, but was only half of what the company projected earlier this year.
The volatility in the stock price has been tremendous over the past year. In the summer of 2011, NFLX announced it would be raising prices and splitting the company into two parts -- streaming and mailing. This inflicted a tremendous amount of fear within investors and shot the stock down nearly 80% from its $300 highs. This type of volatility is something investors do not want to see. It points to instability in the business model and fickleness of the Internet customer.
Here are three reasons to stay away from NFLX:
An Ailing Business Model: Analysts and business tycoons alike have been commenting on the trouble that Netflix is facing in regard to its business model. The following are reasons NFLX may be heading toward the brink.
- Porter Bibb, managing partner at Mediatech Capital Partners, recently stated in a Washington Post interview that Netflix is operating an unsustainable business due to the industry wide trend is the increase in cost of production material. The major production houses are increasing the cost for Blockbuster, Netflix, and theaters to buy content. To date, Netflix owes roughly $5 billion in content debt. At the same time the company is only holding $365 million in cash. This disparity calls for prices to either rise or NFLX profit to fall dramatically.
- The fickleness of both investors and members of Netflix has been seen over the past year, when prices went up and members quit the service. When members quit the service, investors sold. This has the ability to run cyclical trends through the company and add tremendous volatility. This type of stock and member movement is not conducive to long-term success.
- Members are not signing up in the packs they used to because prices are elevated (due to the aforementioned reasons). This creates a landscape for Internet media where competition is fierce and no allegiance is held with any media provider. With free mediums like Hulu, YouTube, and network applications, Netflix may have a very difficult time both building client base and keeping prices low. Netflix does not have a deal with its content holders like Pandora (P) does, where content fees are regulated. Rather, the increase in competition and the decease in content Netflix can afford has the potential to bring the company to its knees.
Short Sellers: In most cases, the combination of having a large percentage of shares shorted while simultaneously having a strong earnings report will lead a stock to gap up. This is in part because short-sellers want to cover before a move to the upside. In the case of NFLX, this happened to some extent when earnings were released on Thursday, but the company still has 23% of its shares shorted.
To add to this level of insecurity within the company is the prospect that Netflix CEO Hastings himself stated that Amazon (AMZN) will be entering the list of companies that will be streaming media. Due to this potential and the sentiment on Wall Street about Netflix's poor business prospects, the momentum may further fall to short side in the coming weeks after the hype of the lackluster earnings were reported.
Potential Buyout: As a general rule, it is not wise to invest in a company when rumors of a potential buyout are ringing in the ears of Wall Street. Porter Bib stated, "I would be surprised if Netflix is its own company in a year." Earlier in January, rumors of a potential Yahoo (YHOO) buyout of NFLX surfaced and sent the stock higher. The problem with owning a stock that could be bought out is that speculation can breed a tremendous amount of volatility. NFLX has had so many swings to the upside and downside that is difficult to predict the future as it is. Adding in the complexity of a buyout would even further complicate the company's situation.
Conclusion: It is wise for investors to follow Warren Buffett's advice:"If calculus or algebra were involved in becoming a great trader, I'd have to go back to delivering papers." Netflix is a complicated company with complex business decisions to be made in the future. If Wall Street cannot understand where Reed Hastings wants to move the company, the stock will prove volatile in the future. Stay away from NFLX unless you want to take a rollercoaster ride where your wallet might just fall to the ground.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
