Netflix Is Too Volatile For Your Portfolio

| About: Netflix, Inc. (NFLX)

Netflix (NASDAQ:NFLX) provides Internet subscription services for TV shows and movies in the United States and internationally. Netflix reported third-quarter earnings after the bell on Oct. 23. The company reported revenues of $905 million, which was a 10% increase from revenues of $822 million in the third quarter of 2011. Net income was $7.7 million, which was an 88% decrease from revenues of $62.5 million in the third quarter of 2011. Earnings per share came in at $0.13, which was a 91% decrease from earnings per share of $1.19 in the third quarter of 2011. Netflix reported that its total number of unique subscribers was 29.9 million, which was up from 23.8 million in the third quarter of 2011.

Despite the fact that Netflix revenues were up, its net earnings were much lower. The primary reason for this is because of the company's ambitious and expensive foreign expansion projects. The company is expanding its business in Latin America where it now has more than 1 million subscribers. The Latin America expansion has suffered because people are reluctant to transfer credit card information over the Internet there. Netflix CEO Reed Hastings said, "It will take longer than we had planned to get to profitability in Latin America." The company is also expanding into the United Kingdom and Ireland where it has about 1 million subscribers. On Oct. 18, the company made its streaming services available in the Scandinavian countries of Denmark, Norway, Sweden, and Finland. In addition, the company has announced that it plans to expand its service to France in 2013. These expansion projects are expensive, and the company's marketing expenses as well as its technical and development expenses increased dramatically.

Another problem Netflix has run into is that while it is increasing its subscriber base, the base is not growing as fast as projected. Netflix reported 25.1 million U.S. subscribers for the quarter, adding 1.16 million in the quarter. That's compared to its forecast of 1 million to 1.8 million new additions. The company had projected that it would add 7 million domestic subscribers this year, but through the first three quarters it has only added about 4.1 million. Internationally, Netflix added 700,000 new members in the quarter -- bringing the total number of international streaming subscribers to 4.3 million, stronger than initially forecast. But, the company's DVD-by-mail business continued to lose subscribers during the quarter. The loss of DVD customers hurts Netflix because its DVD customers are currently more profitable than the company's streaming video subscribers.

Future Projections

During the earnings conference, Netflix conceded that it would probably lose money in the fourth quarter because of its launch investment in Scandinavia. The company projected that domestic subscriptions will rise to 26.4 to 27.1 million with revenues of $581 million to $588 million by the end of the fourth quarter. Domestic DVD subscriptions are expected to be between 7.85 million and 8.15 million, with revenue between $248 million and $255 million during the same the fourth quarter. International subscriptions are expected to rise from 5.2 to 5.9 million with revenues of $90 million to $100 million. Earnings were projected to be between a loss of $0.23 per share to a profit of $0.04 per share. The Zacks Consensus Estimate is pegged at a loss of 8 cents per share.

Recent News for Netflix

  • On Oct. 24, it was argued by Louis Bedigan that Hulu should consider buying buying Netflix in order to instantly add to its movie library and number of subscribers. The key to the deal for owners NBC, Fox -- owned by News Corp. (NASDAQ:NWS) -- and ABC, owned by Walt Disney (NYSE:DIS), would be the ability to lower content costs when contracts were up for negotiation. A beat-up Netflix is also starting to unfurl an entry point that might look enticing for the well-funded trio of owners.
  • On Oct. 23, it was reported that in addition to issuing soft subscriber growth guidance in his company's Q3 report and shareholder letter, Netflix CEO Reed Hastings made waves by admitting competition from Amazon, Hulu, and others is a matter of concern, and predicting HBO -- owned by Time Warner (NYSE:TWX) -- will launch a streaming-only U.S. service. Also of concern are that Netflix's "known" content liabilities total $5 billion, of which $2.1 billion are due in the next 12 months, and that domestic streaming's contributing margin remains approximately one-third that of the declining DVD business.
  • On Oct. 23, it became known that Netflix will see negative cash flow the third quarter. The company missed estimates with its outlook for net domestic streaming subscription additions, lowering the mark all the way down to 4.7 million to 5.4 million from prior guidance of 7 million.
  • On Oct. 22, Netflix's stock rallied after The Next Web noticed a job listing for linguists capable of translating "marketing, UI, and content materials" into "Turkish, Dutch, Hindi, German, Italian, Norwegian, Korean, and Japanese." That's fueling speculation that Netflix is planning to enter some of the markets where those languages are spoken. Norwegian audiences are already covered by last week's Scandinavian launch.
  • On Oct. 18, it was announced that Netflix's streaming services are now available in Scandinavia. The company had previously said a launch would happen by year-end. Some local content is provided alongside international offerings. Amazon's Lovefilm already operates in Denmark, Norway, and Sweden. HBO is about to launch a streaming-only service in the region as well.


Netflix announced earnings on Oct. 23, and on Oct. 24 the stock price dropped by 13.4% on almost three times normal volume. There are a number of reasons for the stocks crash (a recent run-up in the stock price, an 88% reduction in earnings, and a predicted fourth-quarter loss), but the biggest reason was because the company did not meet new subscriber expectations. Netflix trades as a growth stock, and its high valuations (price/earnings ratio of 34.2 and price/book ratio of 5.5) are based on the premise that the company will grow at a rapid rate. This stock is volatile, and when it fails to meet expectations the stock price will always take a big hit.

In the period between Sept. 25 and Oct. 23, Netflix's stock price increased by 26.8%. On Oct. 22, the stock rallied by 4.4% based on an unsubstantiated rumor that the company was considering moving into even more foreign markets. The expectations for Netflix were so high that the stock was bound to crash when the company did not meet expectations.

I do not consider Netflix to be a good long-term investment because the company has inconsistent earnings. Also, it will have to fend off extremely strong competitors such as Amazon (NASDAQ:AMZN) and Verizon (NYSE:VZ), which will also be offering streaming video services. I do consider Netflix to be a trading stock that could be a good short-term investment after the crash in its stock price.

Disclosure: I 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.

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