by Robert Gordon
The roosters have come home to roost at Netflix (NFLX). Following one of the great internet era management fiascoes, the company's profit picture has not surprisingly plunged, and while the company is not at risk for failure, it is a long way from retaining its old profitability. Let's take a look at Netflix, among the most successful of the internet era companies, along with a few of its younger internet-based brethren.
In mid-2011, management posted on its webpage a fundamental change in how Netflix would interact with and serve its customers. It is not as if the company was under any particular pressure, or was not highly profitable when the announcement was made. Revenue in full year 2011 of $1.79 billion was up 56% from 2010. Profits for the year of $226 million, or $4.16 per share, were a 41% year over year advance. One might think such numbers would satisfy any management and shareholder partnership. Maybe the business plan could be tweaked a little, or made more efficient, but to totally redo its company's user system made absolutely no sense.
As you will recall, Netflix decided, with some justification, that it made little sense to charge a flat fee for internet streaming and be able to charge only another couple dollars a month to include unlimited DVD / Blue-ray rentals. So, management figured, let's just split the business into two, and both halves can charge what the market will bear. Netflix customers were outraged, and in a scenario, reminding me of New Coke in the 1980s, management scrapped the plan, even before it was actually put into place.
No one would confuse Netflix with Coca-Cola (KO), which quickly recovered fully after the New Coke fiasco. But Netflix pressed on, and put into effect its plan that it would have under its own banner separate fees for streaming and rentals, effectively nearly doubling the price of Netflix to many customers. The damage to reputation was done, and the company suffered a loss of some 800,000 customers in the third quarter of 2011. The core domestic unit grew by some 600,000 in the fourth quarter of 2011, and then by another 1.6 million in the first quarter of 2012.
But to acquire all these new customers, promotion and marketing, and especially content costs skyrocketed. Added to that was the cost of establishing new markets in Europe, and for the first time since 2005, Netflix actually recorded a net loss. Earnings in the first quarter of 2012 came to a loss of $5 million, or eight cents per share.
For all of 2012, Netflix is forecasting earnings of between ($6 million) and $8 million. The company, which nine months ago had a stock price of about $300, has seen about $12 billion of market capitalization evaporate. All this from a company that did not need to change, but some hidden compulsion forced it to, to its own detriment.
Looking forward, Netflix is counting on tremendous growth in its new markets in Great Britain and Ireland. Yet, I see no evidence in the company's ability to be profitable as content acquisition; as expensive as it is domestically, it is even more expensive in Europe. Analysts see earnings back to over $2 per share by 2013. I really question that optimism. I would be on the sidelines for now, as I see far more downside that upside in Netflix stock over the next 6 to 12 months.
Groupon (GRPN) only has been around as a public company for about six months, and shareholders cannot be too pleased. After an initial offering priced at just over $26 per share, the price has declined to about $10 per share, wiping out some $10 billion in capitalization in the process.
There is utter and complete conflict of the perception Groupon's program has upon its customers. Marketing company Icontact named it the most disliked among small business owners along all social internet outlets. A Groupon commissioned study showed it to have substantially above average customer satisfaction, bringing to its customers a variety of benefits.
Analysts generally see tremendous growth in both revenues and profits for Groupon. I see the proliferation of competitors, from privately held LivingSocial to numerous local competitors, subduing that growth. Groupon will release its first quarter number May 14th. Any level of profitability would deem the quarter a success. Analysts have lowered their expectations for this year from $0.31 per share 90 days ago, to $0.20 per share now. I need to see some proof that the company can operate at a reasonable level of profitability. I might also note that as of this writing, the stock is on a month long, steep price decline. I know little of technical investment theory, but I can spot a trend chart as bad as this one easily enough. Avoid Groupon.
Sometimes, I run across a company I know I like, and have to do a double take when I see the current stock price. Hello Amazon (AMZN). This high-flying internet retailer has become such a dominant force in books and music, it was a key reason for the failures of brands such as Circuit City and Borders. There is no question about this company's profitability. But a trailing price to earnings ratio of 184, and a future price to earnings ratio of 88 should give any value investor serious qualms.
Analysts see Amazon's five year profit growth at 30% annually. But even so, with a five year PEG of 6.4, there are few more overpriced equities out there. I see no real limit to Amazon's ultimate growth, but it will take more than a few years of impressive growth to justify even the current price, let alone capital appreciation. I would hold the company if I owned shares, but it is far too rich for my blood to recommend to anyone else.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
