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Netflix Is Facing Some Competition. Should It Be Concerned?

|Includes: Netflix, Inc. (NFLX)

Summary

Hulu just purchased the online video rights to the show "Empire".

After reaching an all time high of $692.79 Netflix has retraced almost 5% this past week.

Technically there is a gap from $594 to $600 that needs to be filled.

Editors Note: This article was written prior to NFLX's 2015 7:1 stock split. Adjusted for the split the NFLX stock price objective at the time of the article was $103.

Netflix (NASDAQ:NFLX) has continued it's parabolic rise in 2015. Why? Much of the jump was credited to the new buy recommendation from Nat Schindler and other analysts from Bank of America Merrill Lynch a few weeks ago. What stands out regarding the upgrade is the fact that the price objective is $722. This aggressive stance comes despite NFLX continuing to make new highs practically every week.

Netflix has also requested that the number of outstanding common shares be increased over 30 fold from 160 million to 4.99 billion shares in their most recent SEC Proxy filing and the company has stated that they intend to split the stock after the authorized shares are approved.

So can the stock meet or even exceed this price target? My guess is no. Now may be the time to sell. This type of price target is characteristics of price targets seen in the dot com bubble. High was never high enough. As the stock rallied hardly any analysts were ever able to type the word "SELL"; likely for fear of creating animosity. Here is the current breakdown of analyst recommendations:

  Current Month Last Month Two Months Ago Three Months Ago
Strong Buy 10 8 7 7
Buy 16 14 15 15
Hold 13 17 19 19
Underperform 1 2 1 1
Sell 2 2 2 2

This is despite the reductions in earnings estimates:

  15-Jun 15-Sep 15-Dec 16-Dec
Current Estimate 0.3 0.36 1.49 3.52
7 Days Ago 0.32 0.38 1.48 3.48
30 Days Ago 0.32 0.41 1.45 3.51
60 Days Ago 0.35 0.46 1.8 3.67
90 Days Ago 0.93 0.93 3.37 5.47

I admit that Netflix has done well. It has weathered a few PR blow ups and their subscriber base is growing again. But how sustainable is that growth in the long term? Current price targets leave little room for error.

All one needs to do is look at what happened to LinkedIn(LNKD) or Twitter(NYSE:TWTR) last week when both lost 20% of their value in one day when missing the street goals for revenues and/or profits.

So what can go wrong? Plenty. And it is there for all to see.

In the latest NFLX SEC 10q filing there are a few red flags. Among them are:

* Long term debt increased 167% after two bonds were sold in February 2015 totaling $1.5 billion

                  Level 2 Fair Value (1) as of
  Principal Amount at Par   Issuance Date   Maturity   Interest Due Dates   March 31, 2015   December 31, 2014
  (in millions)               (in millions)
5.375% Senior Notes $ 500.0     February 2013   2021   February 1 and August 1   $ 510.0     $ 520.0  
5.750% Senior Notes 400.0     February 2014   2024   March 1 and September 1   407.5     416.0  
5.50% Senior Notes (2) 700.0     February 2015   2022   April 15 and October 15   715.8     -  
5.875% Senior Notes (2) 800.0     February 2015   2025   April 15 and October 15   821.0     -  

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* Also noted in the most recent 10q is the flat lining of the companies Domestic DVD revenues - with average monthly revenue per paying membership up just 1% year over year and those memberships generating a $203 million loss.

As of/ Three Months Ended   Change
    March 31,
2015
  March 31,
2014
  Q1'15 vs. Q1'14
    (in thousands, except revenue per membership and percentages)
Memberships:                
Net losses   (203 )   (278 )   75     (27 )%
Memberships at end of period   5,564     6,652     (1,088 )   (16 )%
Paid memberships at end of period   5,470     6,509     (1,039 )   (16 )%
Average monthly revenue per paying membership   $ 10.37     $ 10.26     $ 0.11     1 %
                 

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* Absent the $1.5 billion in new log term debt ($1.482 billion net to company), cash & cash equivalents would have decreased 18%

March 31, 2015   December 31, 2014
  (in thousands)
Cash and cash equivalents $ 2,454,777     $ 1,113,608  

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* Finally, the Non-GAAP Free Cash Flow reconciliation saw a decrease of $163 million in the latest quarter.

Three Months Ended
  March 31,
2015
  March 31,
2014
  (in thousands)
Net cash (used in) provided by operating activities $ (127,382 )   $ 36,359  
Net cash (used in) provided by investing activities (42,822 )   57,639  
Net cash provided by financing activities 1,522,434     458,186  
       
Non-GAAP free cash flow reconciliation:      
Net cash (used in) provided by operating activities (127,382 )   36,359  
Acquisition of DVD content library (22,906 )   (14,914 )
Purchases of property and equipment (13,036 )   (13,334 )
Other assets 225     295  
Non-GAAP free cash flow $ (163,099 )   $ 8,406  

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The combination of all three in the same quarter is disturbing. After reviewing other major technology companies such as Apple(NASDAQ:AAPL) and Microsoft(NASDAQ:MSFT) I can not find one quarter where all the above three items occurred at once.

While none of the above facts by themselves are long term problems for NFLX, when one starts to make a list they are all red flags that need to be watched; especially when analysts are expecting a 30% rally from record highs. While the company is indeed firing on eight cylinders now, history has taught us that nothing is guaranteed when investing.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.