Share Buybacks a Good Sign from Netflix

A little over a week ago, I wrote that Netflix (Nasdaq: NFLX) shares were a bargain. Since then, Goldman Sachs Asset Management has indicated that their stake in Netflix rose from 3.12% to 5.4%, and Netflix announced the authorization of a $100 million stock buyback. Both announcements are positive signs for shareholders. Netflix’s stock has risen approximately $3.00 per share, or 13%, in the past week.

A Good Problem to Have

Just looking at the cash flow statement released at the end of their fiscal year, Netflix reported $290 million in cash flow from operating activities. Of this, $245 million was invested back in the business as capital expenditures and net expansion of their DVD library. Additional cash was added due to tax benefits for stock-based compensation and issuance of shares related to stock-based compensation, bringing total additional cash to almost $80 million.

At the end of their 2006 fiscal year, Netflix had $5.80 per share in cash on their balance sheet. In the estimation of management, this apparently is more than enough cash to meet their long-term business needs, so Netflix bought back nearly $100 million in stock in 2007. Now, they are planning similar buybacks in 2008.

Companies have several choices when their business does not require the cash they hold. They can:

1. Play Defense and Hoard the Cash
2. Make Acquisitions
3. Pay Dividends
4. Buyback Shares

Provided that shares can be purchased at or below their intrinsic value, I view share buybacks as the preferred use of excess cash for Netflix. It is difficult to generate superior returns with cash. It would be much better to have that cash invested. Sometimes there are no opportunities to deploy cash in a shareholder friendly way. Companies like Ebay that generate loads of cash, have wasted money on poor acquisitions (think: Skype). Other businesses, like Berkshire Hathaway perhaps, have leaders who can expertly put a large cash hoard to work. This, however, is a rare talent. A company could also pay dividends, but this does not provide tremendous benefits to investors who hold shares in taxable accounts. In the case of Netflix, I think share buybacks are preferred provided that shares are purchased at a discount to their true worth.

Conclusion

As I noted previously, Netflix now has about $5.75 per share in cash. In 2008, they will likely produce more cash flow than they generated in 2007. At current prices, share buybacks are the preferred use of cash for Netflix. To hoard cash would reduce returns, and an acquisition for Netflix may do more harm than good.

Disclosure: Long NFLX

Comments

[wall_st_geek]

5. They can make strategic investments (without acquisition).

I'm not quite as positive on the buyback. I just see it as a continuation of a previous trend, and anticipate that much of the purchased stock will be issued in options to employees (not in itself a bad thing), so is nothing to get particularly excited about. Plus the amount doesn't exactly ring of "we think our stock is a screaming buy and are going to profit from all you who don't believe in us".

Personally, I would have preferred them to announce a new strategic initiative - perhaps accelerated overseas expansion, an adjacent space opportunity or partnerships with cable cos to replace their PPV services....now those would have been exciting.