Back in February, William D. Cohan noted in Vanity Fair that Tony Wible, a research analyst who covers Netflix (NFLX) for Janney Montgomery is one of my "heroes." While I will not be serenading Wible with Bette Midler anytime soon, I do appreciate and agree with his views on Netflix.
He's out with a note this morning, where he (sort of) serenades me:
Internal Memo - Rocco Pendola of Seeking Alpha and TheStreet.com reports having seen a recent internal memo to IT staff that references "Split 2.0". While NFLX representatives have downplayed the memo's reference as internal IT jargon, and it may merely reference the aforementioned UI update, this term seems much more relevant in light of all the other data points.
Slapping a SELL rating and $55 price target on the stock, here's how Wible sees things heading into Netflix's Monday earnings call:
Point of Failure - If NFLX were facing a slowdown, the DVD business would ostensibly be more prone to weakness, as it should have a higher correlation with the internet tracking data given the DVD sub's dependence on the NFLX website. However, this business is highly profitable and NFLX has not pre-announced, which could imply: 1) there is no slowdown; or 2) the slowdown is partly tied to the lesser profitable streaming business.
Qualitative Support - NFLX's actions may also support the notion of a slowdown. The company recently changed its DVD acquisition technique, spoke of partnering with MSOs, and has taken actions that could suggest there is another attempt to split the services. The acquisition of DVD.com, the recent change in UI, and internal reference to "Split 2.0" could be seen as a way for NFLX to establish a cleaner separation between the two services and the Netflix brand, which may be warranted if NFLX were to ever pursue strategic alternatives and/or partnerships.
Lowering Numbers - The aforementioned mosaic could very well be wrong, in which case there would be reason for renewed optimism. It is difficult to make a bold call on the quarter, but we believe risk is elevated and more caution is warranted, which leads us to reduce our estimates and fair value.
A few thoughts on Wible's take. By and large, I agree with it. That said, I have always been rather uneasy about using traffic to Netflix's Website to judge the company's condition. When Netflix made mainstream, national news last year, traffic to Seeking Alpha, at least from what I am able to tell, spiked. Naturally, people wanted news on what was happening so they Googled "Netflix" and other terms leading them here, there and elsewhere. We should be ready to attribute the tapering off of traffic to Netflix stepping out of the headlines as much as we are willing to chalk it up to slow growth.
Instead, if there is a DVD slowdown, it's Netflix's fault. And you really do not need to analyze Web traffic to read the writing on the wall. As Wible ably noted, a confluence of factors contribute to a potential slowdown in DVD, not the least of which is the recent surprising preannoucement from Coinstar (CSTR).
Wible also believes there's a good chance Netflix's subscriber numbers will come in at the low-end of the company's guidance. He's smart, however, to urge caution. Cynics will argue that it's yet another case of an analyst covering his butt, but I do not buy that. Netflix projects a murky picture right now. There's not much that would surprise me on Monday, ranging from an earnings beat to the worst quarter in the company's history. Depending on how much color Netflix gives us in its earnings-related documents and conference call, I believe I will be able to make a more confident case for the rest of the year.
No matter what happens next week, Wible's price target of $55 is closer to reality than the current market price of $108. One false move and this thing implodes. That said, I have slowly changed my tune on Netflix CEO Reed Hastings over the last year.
While I disagree with him on many aspects of his company's business, I like the way he thinks. The decision to leave the DVD segment for dead so soon remains a bad one. In my opinion, it will give Netflix no other choice but to find a way to raise money sometime this year. It could go to market again, but that would not look good, therefore I think the company slaps a "For Sale" sign on its DVD operation. At present, it does not have a suitable revenue stream to even have a chance of executing Hastings' progressive and ambitious vision for the future.
If you're holding a lotto ticket, so to speak, that requires a complete implosion to become profitable again (like I am), I say "go for broke" if you can afford it. That was my plan last year when I picked up more NFLX June $40 puts. To make that sort of deep OTM options trade ahead of earnings this quarter, in either direction, is nothing short of gambling. It probably was last year as well, but it's one of the few low probability positions you'll see me commit to.
Fellow Seeking Alpha contributor Kim Klaiman provides an example of one way to play NFLX prior to the company's report here.
Disclosure: I am short NFLX.
Additional disclosure: I am short NFLX via a long position in NFLX put options.