Netflix (NFLX) reported earnings after the close Monday. When I saw the initial results hit my screen, I expected the stock to soar. In fact, it initially ran up to around $111. It quickly retreated, however, crashing and settling in the $85 neighborhood.
Frankly, I am a bit surprised this happened. While not good, the results were not awful. I do not think they drastically enhanced the standard bear case. At the same time, they did little to erode it. Ultimately, I think the Street punished Netflix for several reasons:
- The company reported a loss. While this was expected, I have noted several times in the past that the stock might not end its dead-cat bounce and retrace its lows until the anticipated loss became a reality. It's like knowing a loved one is going to die, but not unleashing all of your emotion until the day actually comes.
- Netflix does not expect to turn a profit in the UK/Ireland and Latin America for more than two years.
- Netflix is no longer a hyper-growth company like Lululemon (LULU), Chipotle (CMG) and others. Those days are gone. While it spends like a hyper-growth company, it no longer grows like one. Consider the numbers: Year-over-year, revenue was up 21% this past quarter, down from growth in the upper 40s/lower 50s in the previous four quarters.
- If Q2 revenue comes in at the high-end of Netflix's guidance ($895 million), that marks just a 2.9% quarter-to-quarter increase and a 13.4% year-over-year increase. If it comes in on the low-end of guidance ($873 million), Netflix will see just 0.3% quarter-to-quarter pop and a 10.6% year-over-year jump.
For the record, I produced each of the last three points from the above-linked Netflix Q1 letter to shareholders.
Netflix is stuck in a rut. Wall Street will only continue to bid up high growth companies that are either profitable or show a clear path to meaningful profitability. Netflix has taken several steps back on both counts. Without the high-flying numbers it has put up in the past, any improvement -even a return to the black - will only underwhelm momentum and growth investors. The ones who were left after last year's crash moved on Monday in after hours trading.
In the coming weeks, I will expand on the aforementioned points and cover other areas of the results. I close this article by focusing on Netflix's DVD business, which continues to erode. Other than Reuters pointing out what amounted to a grunt from Reed Hastings in response to a question about selling the DVD division (I think he said they will not), I have not seen the media say much about DVD in the post-earnings crush.
Consider what I wrote back in early January:
As the company effectively dissed its DVD customers, heavy users like my neighbor, Ginger, are probably the ones left standing. Ginger has two DVDs in the outgoing mail every other day. She's taking Netflix to the cleaners. Because Netflix does not give us this level of color, I can only speculate, but I reckon the ultra-profitable DVD customers (those who hardly used that side of the service) are gone, while leaches like Ginger remain.
To this day, Ginger has kept that same pace. Every single day, she has a DVD in outgoing mail. Sadly, she's moving next month, but I think it's safe to say that lots of people like Ginger exist in the United States. And they likely represent a lion's share of Netflix's remaining DVD subscribers.
There's no other way to put it: Reed Hastings and his team have absolutely butchered the transition away from DVDs. Based on the results in DVD, I can only assume they're left with heavy users like Ginger. People like her are expensive to service because they pay one low price, yet Netflix incurs greater fulfillment costs on these customers. It likely has far fewer DVD customers, with the service separated out at $8 a month, who just keep the perk around in case they got the itch for a DVD.
DVD revenue was down 13.5%. DVD contribution profit dropped 24.7%. And DVD contribution margin tanked 13.0%. Bulls will likely spin this as "good news," arguing that this means subscribers are shifting to streaming in droves. I do not concur. The most profitable DVD customers are jumping ship and the most expensive ones to take care of are sticking around.
Quarter-to-quarter, fulfillment costs were down just 4.2%, however, Netflix does not break down how much of these costs are attributable to DVD and streaming. I can safely assume that most of the company's fulfillment expenses hit on the DVD side of things, but I am not certain exactly how much. This line item, along with increased marketing costs (up 19% quarter-to-quarter) and off-balance sheet obligations (to be announced in the forthcoming 10-Q filing), warrant attention going forward.
In summary, things were not nearly as bad as I expected. That said, they're still far from good. Netflix is no longer a hyper-growth story. Relatively speaking, it sports moderate growth during a fragile turnaround attempt littered with uncertainty. Wall Street tends not to slap lofty multiples on companies in this type of situation.
As it stands, I might just break even on my NFLX June $40 puts. Depending on how things shake out as the dust settles in the stock this week, they might no longer be the laughingstock of Seeking Alpha. In any event, those puts could turn profitable for me on considerably more weakness over the next 30-60 days.
While I do not think it makes sense to enter them now, if NFLX cannot close above $90 for the rest of the month and sustain there, I think it's relatively safe to assume (nothing is completely "safe to assume" in this business) the stock will not see $100 for quite some time. To command a lofty valuation, Netflix must get back into the hyper-growth club with stocks like CMG and LULU. I do not see that happening anytime soon, if ever.
Additional disclosure: I am long NFLX June $40 put options.