Netflix's Earnings: The Good, The Bad, And The Ugly

Apr.24.12 | About: Netflix, Inc. (NFLX)

Netflix (NASDAQ:NFLX) has been under tremendous pressure as the company has had a difficult year, to put it mildly. Last summer the stock was continuing its ascend to 300 only to tumble to the 60s before rebounding to 100 to start 2012. After declining over four percent on Monday, the stock is sitting on a sixteen percent loss afterhours due to its disappointing earnings announcement.

I have been bearish on Netflix since September due to its low barriers to entry and my stance was solidified by the company's overconfident management. Below is my rapid reaction to Netflix's quarter as it is certainly a mixed bag.

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(Source: Yahoo Finance)

The Good: 1.7 Million Net New Digital Subscribers

Netflix added 1.7 million U.S. subscribers in the quarter which comes close to reversing the subscriber loss attributed to the Qwikster debacle. Despite the rebound, analysts expected more as Netflix will need to prove that it can triumph over a crowded competitive landscape. In contrast, the cash cow Netflix DVD business lost 1.1 million subscribers.

As I have written in the past, Netflix needs to be very careful to not just simply "convert" DVD customers into streaming customers because it provides minimal benefit for the company. Yes, it is important for the company to eventually convert those customers but the overall growth in streaming needs to far surpass the DVD losses. Overall I am happy with this number because it is a step in the right direction, but the company has to make significant progress to regain investors confidence.

The Bad: The Quarterly Loss

Netflix lost $4.6 million in the most recent quarter after posting a $60.2 million profit in the first quarter 2011. Much of the decline in profits was due to sharply higher costs, much of which are associated with the company's attempt to penetrate foreign markets. Netflix's management knows that the company needs to continue to add subscribers in order to please analysts; however, the cost of attracting new customers is very high.

Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Comcast (NASDAQ:CMCSA) and other rivals are in far superior financial condition to woo content producers. In essence, Netflix cannot afford a prolonged fight with these competitors but instead must stay agile in its marketing. Management needs to focus on returning to profitability by scaling back growth plans and focusing on customer retention. Rather than churning customers, Netflix would be better served maintaining what customers it has and growing at the same time.

The Ugly: Guidance and Plans For Future

To elaborate on my main point, Netflix has been over-expanding rather than serving its existing customers. 2011 showed that Netflix's customers are not nearly as loyal as they once thought. The company needs to dedicate more resources towards building the streaming library rather than expanding into foreign markets that will only hamper profitability.

While Netflix expects to be profitable in the second quarter, the company plans its next major international market launch later this year which will very likely return the company to a loss situation. Even with this anticipated growth, subscriber growth is expected to slow further and the days of unbridled growth are in the past. This poor guidance is likely the primary factor behind Netflix's afterhours tumble.

My gut reaction to the quarter's results is that Netflix has a very uncertain future ahead. If everything goes right for the company I can see them returning to solid profitability and enjoying respectable growth. On the other hand, I think there is a very realistic possibility that Netflix will get bogged down in an expensive hunt for additional subscribers. With a fifty-fifty chance of being successful, I would rather risk my money on technology companies that are less risky. Look to invest your money elsewhere but be very careful if you decide to short this former high flyer as a quick rebound can force you out of the position in a hurry.

Disclosure: Long AAPL and AAPL May 700 Calls.