Netflix - Short-Term Disappointment Provides Investors With Long-Term Entry Point

Jul.25.12 | About: Netflix, Inc. (NFLX)

Shares of Netflix (NFLX) fell up to 17% in after hours trading on Tuesday after the internet television streaming company announced its second quarter results.

Second Quarter Results

Netflix reported second quarter revenues of $889 million, up from first quarter revenues of $870 million. Last year the company generated $789 million in second quarter revenues. Netflix earned $6 million, or $0.11 per share for the second quarter. This compared to a loss of $0.05 per share in the first quarter of 2012 and a profit of $1.26 per share in the second quarter last year. On average, analysts were looking for the company to report earnings per share of $0.05.

CEO Hastings commented on the results, "We have enormous challenges ahead and no doubt will have further ups and downs as we pioneer Internet television."

Segmental Information

Domestic Streaming

The company generated $533 million in domestic streaming revenues, up from $507 million in the first quarter of 2012. Domestic streaming still generates 60% of firmwide revenues. Contribution profits rose from $67 million to $83 million on the quarter. Contribution margins rose 240 basis points to 15.6% amidst a reduction in marketing expenses. The company net added 0.53 million new subscribers, now having a customer base standing at 23.94 million. This quarter's growth is a marked slowdown compared to the 1.74 million in net customer additions in the first quarter of the year.

International Streaming

International revenues rose from $43 million in the first quarter to $65 million in the second quarter. The company generated only $19 million in quarterly revenues in the second quarter of 2011. Contribution losses came in at $89 million which compares to a loss of $103 million in the first quarter of 2012 and a $9 million loss a year ago. Net subscriber additions came in at 0.56 million. Netflix now has a 3.62 million subscriber base for its international activities. Again, growth has slowed down as the company added 1.21 million new subscribers in the first quarter of 2011. Growth in Canada, the UK and Latin America has been solid, although slightly below expectations due to payment systems issues in Latin America. The company will start operations in a fourth European international market in the fourth quarter of this year.

Domestic DVD

The domestic DVD business which acts as a cash cow for Netflix saw 0.85 million net customer defections and it now serves 9.24 million customers. In the first quarter, some 1.08 million customers have ended their subscription. Revenues fell from $320 million to $291 million on the quarter, while contribution profits fell from $146 million to $134 million. Contribution margins remained very high at 44.0%.


The company keeps heavily investing in international markets using its cash flows from its US businesses. Netflix expects to be profitable in the third quarter, but expects to report a loss in the fourth quarter as it launches its fourth international market.

The company expects to end the third quarter with 24.9-25.7 million domestic streaming customers, up 1.0-1.8 million on the quarter. This compares to net additions of 0.53 million in the second quarter. International subscribers are expected to grow to anywhere between 3.9-4.4 million, up 0.3-0.8 million. Domestic DVD customer defections will come in between 0.6-0.9 million, reducing the customer base to 8.3-8.6 million by the end of the third quarter. Netflix expects to end up with a bottom line anywhere between a $6 million loss and a $8 million profit.


Netflix ended its second quarter with $813 million in cash, equivalents and short term investments. The company operates with $400 million in long term debt for a net cash position of $413 million. For the first six months of 2012 the company generated $1.76 billion in revenues on which it earned a mere $1.6 million, or $0.03 per share. At this rate the company is on track to generate north of $3.5 billion in revenues and it will most likely post a small full year loss.

Factoring a 15% after hours price decline, the market values Netflix at $3.8 billion, or $3.4 billion for its operating assets. As such the firm is valued at 1.0 times expected annual revenues. This valuation compares to a revenue multiple of 1.0 times for Coinstar (CSTR), 1.2 times for Time Warner (TWX) and 1.6 times for Viacom (VIAB).

Netflix currently does not pay a dividend.

Investment Thesis

Including the declines in after hours trading to around $67, shares trade unchanged year to date. Shares saw a very strong start to the year as shares in Netflix almost doubled to $130 in the beginning of February. From that point in time, shares slowly kept falling to the mid-sixties by June. Shares still trade 75% below their peak of $300 per share in the summer last year amidst the new pricing strategy disaster and trade close near their one-year lows of $60 per share.

Netflix is trying to push forward as quick as it can given the limited resources it has. It aggressively tries to conquer international markets while improving the content of its services. The significant capital expenditures will hurt short-term profitability. Netflix does have to hurry as financially stronger cable companies could invade into Netflix's market.

If Netflix can continue to push out international growth, it could get have the advantage of getting a significant global footprint, making it a global brand. However the moment when the heavy loss making international activities can pay for its own expansion is still far away.

Yet I would still be a speculative buyer if shares are to fall further towards $50-$60 in the coming days or weeks.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NFLX over the next 72 hours.