Netflix (NFLX +6.5%) roars out of the gate with a solid gain as Citi backs the Buy-rated name on...


Netflix (NFLX +6.5%) roars out of the gate with a solid gain as Citi backs the Buy-rated name on the strength of their survey that shows improving customer satisfaction for the first time since last year's "Apocaflix" PR disaster. The Citi take in a nutshell: NFLX can be bought by investors at 10X P/E as its U.S. operations generate $5.50 in EPS, with a free call option on the company's international business. (Also: Whitney Tilson pitches the bull case on NFLX)

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Comments (20)
  • chopchop0
    , contributor
    Comments (5156) | Send Message
     
    assuming content costs don't eat into the bottom line. The truth is that NFLX does not control its own destiny..... content creators/producers who sell to NFLX do.
    3 Oct 2012, 10:10 AM Reply Like
  • Andrew Shapiro
    , contributor
    Comments (2146) | Send Message
     
    The domestic business is not going to earn $5.50/share and what it does earn is diminishing as its DVD business continues its decline while domestic streaming is hitting its saturation point on subscriber growth. It remains to be seen what money-losing Int'l is to be worth.
    3 Oct 2012, 10:53 AM Reply Like
  • biobat
    , contributor
    Comments (4826) | Send Message
     
    $5.50 a share?! WTF.
    3 Oct 2012, 11:00 AM Reply Like
  • wertie
    , contributor
    Comments (7) | Send Message
     
    Great thing about Netflix is whether you are long or short some analyst will support your position. Has been some recent piling on with doomsday scenarios but with a stock like this that depends on its customer base the fickleness of customer loyalty remains the wild card.
    3 Oct 2012, 12:39 PM Reply Like
  • JeffreyLangBoyd
    , contributor
    Comments (663) | Send Message
     
    Agree that there is a very wide range of possibilities but I can't imagine anyone being indignant over a comment that they will earn $5.50 a share on the DOMESTIC business (on an operating basis). How many shares are there? 55.5 million outstanding, another 3-4 million from options and the convertible. It is pretty close to a sure thing they will earn $5.50 a share domestically unless one wants to make some pretty aggressive assumptions regarding subscriber drop-offs or content costs.

     

    Almost seems like no one is willing to acknowledging the fundamental strength of the domestic business. Now international is another story. I don't think they are hitting their targets in Latin America and the start-up costs in Europe are just astronomical. European customers are getting incredible content at a ridiculously low price. There are some articles out there on international but it is a topic that doesn't get nearly the coverage it deserves.
    3 Oct 2012, 01:14 PM Reply Like
  • J Mintzmyer
    , contributor
    Comments (8134) | Send Message
     
    $5.50 a share?!

     

    Hmmm... Are we talking Gross domestic only?

     

    Net per share even with international excluded isn't even $2, or am I missing something here?
    3 Oct 2012, 01:33 PM Reply Like
  • biobat
    , contributor
    Comments (4826) | Send Message
     
    J,

     

    You're not missing anything. The number is totally and utterly out to lunch. Domestically, they aren't earning anywhere near that number now, and where the majority of earnings are coming from (DVD), they're still seeing steep quarterly losses in subscribers.
    3 Oct 2012, 04:35 PM Reply Like
  • J Mintzmyer
    , contributor
    Comments (8134) | Send Message
     
    If I remember correctly NFLX is supposed to be close to $0 EPS on fy12 correct?

     

    Are the analysts expecting a loss of $305M internationally?

     

    It doesn't add up. I'm VERY interested in this quarter to see how they have managed their liabilities. It seems NFLX is actually becoming more frugal in that realm.

     

    Last Spring- I predicted, based on current expenditure rates, that NFLX would go bankrupt in 2013 without a major recap (debt/stock). I want to see if their statements have improved the trajectory.

     

    http://seekingalpha.co...
    3 Oct 2012, 11:04 PM Reply Like
  • JeffreyLangBoyd
    , contributor
    Comments (663) | Send Message
     
    What are you talking about? Unless the loss of DVD customers accelerates or the positive trend with regard to streaming margins stops they will easily earn $5.50 a share.

     

    They earned $105 million domestically last quarter even if one allocates 100% of development and G&A to domestic operations. That works out to around $1.81 a share after making very conservative assumptions with regard to shares outstanding and cost allocations.

     

    Don't forget too that streaming gross margin improvements exceeded DVD gross margin losses last quarter too. International is a money pit; no doubt about it and it will probably get worse when they go into the Nordic countries, but they have a very profitable business here in the U.S.
    4 Oct 2012, 01:10 AM Reply Like
  • J Mintzmyer
    , contributor
    Comments (8134) | Send Message
     
    JLB, you're right in a sense...International revenue was $108M for the past 6 months, vs. expenses of $300.5M. If you take away the entire sector, yes you get $3.29 EPS for the first six months.

     

    That's not a realistic valuation by any terms. IF international was a break-even business I can see the argument. Buy on a forward P/E of roughly 10 and "get the intl for free!"

     

    In this case the international is a liability. That would be like arguing for a different MSFT P/E while removing the last 5-10 years of massive online/search losses-- except even more ridiculous.

     

    DVD drops will continue- domestic sub growth will top out- and huge contract liabilities will hit NFLX this year and next. Q3 will be very interesting!
    4 Oct 2012, 01:24 AM Reply Like
  • biobat
    , contributor
    Comments (4826) | Send Message
     
    Streaming gross margins will only improve until billions in off balance sheet obligations/liabilities become due within the next year. Then it's bye bye margin, bye bye streaming EPS. DVD subscribers, who actually produce the bulk of the domestic EPS are still leaving at levels of 500K+ per quarter and that shows no signs of abating. $5.50 is a pipe dream number that might as well be pulled out of thin air because it's based on the most optimistic of scenarios.
    4 Oct 2012, 06:59 AM Reply Like
  • JeffreyLangBoyd
    , contributor
    Comments (663) | Send Message
     
    The future commitments are disclosed and over the next year they amount to just over $2 billion which is very manageable based on the current revenue level (and in fact would result in huge profit increases) so you appear to be assuming significant new content agreements. Certainly some will be entered into but I'm not aware of anything to indicate things are about to go in the toilet domestically.

     

    Am I missing something in your argument on streaming? If I am missing something what is it?

     

    Regarding DVD, I don't know the future beyond the obvious that it is indeed on a decline, but the rate of decline has dropped a great deal and there is certainly a core group of people who like the convenience and extreme catalog depth at a low price point.
    4 Oct 2012, 10:54 AM Reply Like
  • JeffreyLangBoyd
    , contributor
    Comments (663) | Send Message
     
    You may be right regarding international. The fact is that Netflix doesn't break out enough information for us to assess their plans and performance against prior plans. Suppose that is fair as they are wildly transparent when compared against Amazon/LOVEFiLM and most companies.

     

    I liked the way you referenced your prior article that was in fact wildly wrong. It illustrates extremely well that we are all just guessing and in fact I would argue that NFLX management is guessing too. Their guesses are a little more informed than ours but educated guesses they remain.

     

    Have spent some time looking at the European operations and comparing them to the competition. Know I said it already but folks in the UK/Ireland really are getting access to some incredible bargains. I don't see how they close the gap and get the European operations anywhere close to break even anytime soon but it comes down to the arrangements with content providers. If they are European focused then every single customer in the new markets coming in the fourth quarter are margin and they can move the thing to profitability. If they are strictly country by country and they have not entered into agreements for the Nordic countries then I don't think they will move forward and will just stay in the UK/Ireland and ultimately stagnate unless the content providers reduce their rates.

     

    Ultimately though, I think all the folks saying content are going to break them are wrong. They are a fine channel of distribution and longer term they should be able to carve out a profitable business.
    4 Oct 2012, 12:07 PM Reply Like
  • biobat
    , contributor
    Comments (4826) | Send Message
     
    They lost over 20% of their DVD subscribers last year after the service cut and have steadily lost approximately 10% in each quarter since. While that rate probably will bottom out at some point, it hasn't really slowed down yet.
    4 Oct 2012, 12:20 PM Reply Like
  • JeffreyLangBoyd
    , contributor
    Comments (663) | Send Message
     
    Over the last three quarters the rate of decline has been 20%, 10% and 8% It is a frightening rate of decline but I'm guessing this quarter will show continued improvement.

     

    If Amazon could get a streaming rental product out there at a lower price point and actually make it easy to access I could see the declines continuing but they have not done this yet.

     

    Wonder what Amazon has to pay for the right to stream a movie for rental? Any idea? Vudu/Wal-Mart is cheaper than Amazon but they don't have the same size catalog.
    4 Oct 2012, 04:24 PM Reply Like
  • JeffreyLangBoyd
    , contributor
    Comments (663) | Send Message
     
    I take back part of what I said. I do like Vudu/Wal Mart more than Amazon but they are not always cheaper than Amazon.
    4 Oct 2012, 05:54 PM Reply Like
  • biobat
    , contributor
    Comments (4826) | Send Message
     
    I agree that the disc rental market will slow in decline eventually but I don't think it's there yet. The 20% drop was in response to the price hike/service cut so it's not surprising that it's been higher than the 10% since. Redbox continues to gain.

     

    Amazon's streaming product is at a lower price point ($79/year) and is pretty good. It's got enough good content to keep kids/adults engaged without missing NFLX a bit. The downside is you have to subscribe for a year, the upside is you get free 2 day shipping and can borrow books on your Kindle too. Of course, if you're just interested in catching up on a single series that's available on both Amazon and Netflix, a monthly subscription at $8 will be cheaper. I know quite a few people that are doing that now - hopping in for a month or two to watch what they want and then cancelling. I'll probably do the same thing when Arrested Development gets released, but it will only be a short term gig. Unfortunately for Netflix, an $8-16 contribution for a year from someone isn't really the thing that long term growth is made of.

     

    I've found for most things VUDU/Walmart is comparable to Amazon - at least for newer releases. However, the daily $.99 rentals at VUDU are more prominent, usually have a decent selection, and make it pretty easy to drop a buck for a rental.

     

    FWIW, my streaming use goes AMZN, Hulu, and rarely VUDU. Very rarely Epix or Crackle. I still can't believe Sony hasn't integrated a useful Crackle app into their most popular devices. I haven't used Netflix in over a year and have no impetus to go back to the service anytime soon, barring Arrested Development appearing well before it's planned.
    5 Oct 2012, 08:49 AM Reply Like
  • JeffreyLangBoyd
    , contributor
    Comments (663) | Send Message
     
    I didn't make my point clear. AMZN prime is not going to appeal to a large number of people at least in its present form to the point of dropping Neflix unless it changes significantly from its current form. NFLX is just too cheap and easy to use. You are the exception rather than the rule in my opinion and while I worry about subscription growth in the U.S. and to a lesser extent content growth costs I don't worry about subscription losses. Reasonable people can disagree on this and we will have to wait to see what will happen.

     

    DVD is interesting to me. I think the losses are about to moderate in a big way. I've been thinking that if someone came out with a catalog as deep as Netflix DVD (I think AMZN could do this; Redbox DVD clearly can't) and arranged it so one could watch a reasonable number of movies a month for a fixed fee they could drive further declines in NFLX DVD and probably get some streaming customers too. That might get our family to cut DVD service anyway. May not be economically feasible to do this but it seems like a niche that no one has filled to date. Wouldn't surprise me if that is what Coinstar/Verizon try to do and I think it is close to a no-brainer that AMZN should although their service is already pretty muddled.
    5 Oct 2012, 09:46 AM Reply Like
  • biobat
    , contributor
    Comments (4826) | Send Message
     
    I know more than a handful of people who have stopped using/subscribing to Netflix because Amazon prime finally fixed its horrid UI problem and provides a better perceived value. It's still more common to see people using Netflix but considering a year ago, almost no one I knew used Prime because the UI sucked, it's pretty telling that it's catching on as a streaming option. I agree Netflix is cheap, but it's far too easy to hop in and out of the service. Right now, there's no barrier to subscriber churn - at least domestically.
    5 Oct 2012, 10:30 AM Reply Like
  • J Mintzmyer
    , contributor
    Comments (8134) | Send Message
     
    Jeffrey- I'm double checking my calls here and I seem to be close on revenue and DVD and off on the streaming? The only one that I might be 'wildly' off on is the intl figure, but I actually calculated less of a loss per customer, so it balances out. (Edit: coming back it looks like I misjudged the cost of streaming-- if you have any idea where the huge disparity is coming from please let me know-- I would obviously like to improve the model).

     

    I predicted $3.35B revenue on the year-- 6m in we are at 1.76B revenue-- on track if subs stagnate and DVD drops.

     

    9M avg dvd at EOY-- 6m in we are at 9.15M and 9.96M for the 2Qs- we need to see an average 8.45M for the remaining 2Qs for me to be correct here.

     

    19.5M dom and 2.5M international for 2012.
    19.5M dom and 3.5M international for 2013.

     

    6m we are at 22.7M dom and 3M intl. I didn't forsee the extensive loss leading in Ireland/UK and I didn't expect the fall push into Finland/Norway/Sweden/... I was a bit low on the 19.5M domestic- Q3 will really let us know here...

     

    I predicted $1.01B of opex-- 6m in we are at $477M. Right on track.

     

    I predicted $1.34B NET cost of subs -- 6m in we are at $432M (1,147M-715M)-- I admit that I was way off here-- assuming a 55/45% split on the 6m, I was off by almost 40%.

     

    I predicted $225M fulfillment $17M interest, 6m in we are at $120M/$9.98M.

     

    ----

     

    The net result of my model is a loss of $255M in cash in 2012 / pushing NFLX to a remaining cushion of $243M.

     

    Currently NFLX has $518M net 'quick liquidity' or a gain of $22M.

     

    The 'bomb' for less than one year has shifted from $798M to $2.05B.

     

    1-3: 2.4B to 2.4B // so medium-term liquidity has stayed about the same.
    ------

     

    Let's put it another way-- NFLX has $2.4B due in under a year.

     

    It looks like q-revs will be close to 900M, maybe a bit higher-- let's give them the benefit of 950M average- $3.8B

     

    If opex/interest stays at current run-rate we'll have just shy of $950M there. $2.85B left. Fulfillment looks like it's going to be close to $235M- $295M current liabilities (not including content).

     

    $2.32B left to cover $2.4B / $80M shortfall.

     

    --Here's where it gets really dicy. We are assuming a $70M increase in Q revs while expenses stay flat. In a VERY optimistic scenario they are taking a $80M loss in cash.

     

    What if revenue drops to $850MQ-run? Suddenly the loss is now $480M and NFLX is down to $38M 'quick liquidity' in mid-2013.

     

    ---

     

    This is why Q3 is so important. If NFLX jumps to $950M revenue-spot while holding expenses relatively flat-- the 2013 liquidity crisis model that I built is clearly wrong. We'll see in a few weeks...
    5 Oct 2012, 02:01 PM Reply Like
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