Last quarter, I was able to show investors how to generate an almost 25% return on Netflix (NASDAQ:NFLX) stock in just three months. Before Netflix reported its second quarter earnings in July I advised investors that the stock would almost certainly fall following the report as account consolidation would result in a deceptively shallow subscriber gain that quarter. The stock fell into the mid-$80s before recovering all the way up to $106 at one point, as I also predicted. Now, the next earnings report is coming up, and I am once again taking the contrarian position. While everyone now predicts a substantial shortfall, I believe Netflix will surprise to the upside this quarter on subscribers.
Fraying Market Nerves
Determined not to get caught short again, analysts have been busily revising down their subscriber estimates as the earnings report draws close. One forecast was recently cut from a 300,000 US subscriber increase to 130,000. Another says that there will be no growth at all in US subscribers. There are a few references in some of these articles to predictions that Netflix US subscriber count actually fell last quarter, but I could not find the original primary source material for that claim.
For its part, Netflix is forecasting 300,000 US subscribers. Almost no one else is buying that estimate anymore. The question in the market now seems to be solely on the extent of the shortfall, not the existence of it. Another shortfall would be bad for Netflix stock, but a true collapse in growth to zero or even negative territory would almost certainly be a real body blow, precipitating a fall in the stock perhaps even larger than the one last quarter, which Netflix has completely recouped since.
This quarter, however, I see things playing out somewhat differently. In my opinion, Netflix almost certainly will not report a subscriber loss in the US. And while it may not quite hit its own forecast, I doubt it will fall too far short of it either. Netflix has far more control of its own destiny here than people realize. In fact, even without reversing or modifying the price hike, Netflix can basically manipulate its results this quarter to hit whatever subscriber mark it wants. And since another miss would be very bad for the stock, my guess is Netflix will simply not allow that to happen, but will instead choose to raise the number higher.
A Slow Boil
Let me explain. For those who haven't been following so closely, Netflix has adopted a somewhat more flexible approach to this price hike than it did to the last one. Not in terms of finality - everyone will pay the higher price eventually. But after initially saying it would hike everyone's prices in May, as soon as the price freeze expired, Netflix has shifted to a rolling approach. Now the grandfathered customer base is being transitioned in phases with the longest-tenured customers getting the longest delay in their price hike. Netflix also has not published any definitive schedule. We know what order the price hikes will come in - newest customers to oldest - but not how fast the hikes will roll.
What this means is that Netflix can essentially hit any subscriber mark it chooses simply by varying the timing of the price hikes it announces. We know that customers have been responding to the price hikes by either canceling service or, as I have argued, most of them are probably simply consolidating service into fewer subscriber accounts at a cheaper per-stream price. Netflix presumably has enough data by now after almost six months of hikes to know more or less how much of a churn increase the price hike is producing. If it wants to reduce the churn this quarter, it simply hikes prices on fewer customers.
Massaging The Numbers
There is some indication that this may indeed have happened. Jefferies recently conducted a proprietary survey to measure the impact of the price hike on Netflix customers. In addition to its results on their attitudes toward the price hike and Netflix in general, the survey also asked subscribers exactly when their prices had been hiked.
In reporting the other survey results, I was somewhat surprised that Jefferies chose to mention those almost only in passing. Jefferies data shows that while hikes held rather steady up until Netflix announced results in late July - 26% in both May and July with a slightly smaller 23% in between in June - they began to slow notably after Netflix's subscriber miss sent the stock plunging. Only 18% of the survey participants had received a hike in August, and if the September trend held it was going to finish at 14% - barely half of the earlier level. It seems Netflix management has made a decision to surprise to the upside on subscriber count this quarter.
A lack of disappointment in subscriber counts tomorrow after earnings could translate to a considerable bounce in the stock this week. However, much like the plunge last quarter, I expect this to be temporary. Analysts who look a little closer will almost certainly see that the number is made somewhat less meaningful by the fact of Netflix's massaging of the pricing timing. But there should be an opportunity in the short term to ride a bit of a bounce. My recommendation is to hold the stock through the earnings call and then sell into the rally either Wednesday or Thursday as analysts start to digest - and discount - the earnings beat. Even if you wish to remain long Netflix, there should be an opportunity to pocket some gains this week and buy back in shortly thereafter as the stock returns to the $98-$102 mark it has been trading around for some time.
Netflix learned a bit of a nasty lesson last quarter, and I doubt it has any appetite for an encore. It does not want another big subscriber miss, and it has it well within its power to prevent one at only a slight cost in foregone revenue. A subscriber beat, in turn, should help bounce the stock for at least a day or two and give investors an opportunity to pocket some gains.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.