Netflix (NFLX, Financial) had been serving its shareholders very well when it was growing fast in terms of its business as well as share price. But from July 2011, Reed Hastings got messed up with the strategy of the business, and that led NFLX’s price to experience free fall.
Just yesterday, the company released disappointed results for the third quarter and has a blurred domestic outlook for the future. The worse hit was in the stock price: It was down further, nearly 35% in a day. In the announcement, the third quarter ended with 21.4 million streaming subscriptions and 13.9 million DVD subscriptions. Unique domestic subscribers reduced to 23.8 million, driven by both higher-than-expected cancellations and acquisitions reductions. However, it still had year-on-year growth in gross additions, acquiring 4.7 million new subscribers, achieving 20% year-over-year growth. And the subscriber acquisition cost declined 24% to around $15. The domestic operating profit was at $120 million, with 15% margin, exceeding the target of 14% due to fewer DVD shipments and fewer DVD subscribers and usage.
For content acquisition, Netflix would end the agreement with Starz in February 2012, which controls the pay-cable rights to movies from Walt Disney Studios and Sony Pictures. In the announcement yesterday, the company said that Netflix Streaming Content Quality is 10 times that of Starz, and Netflix would just focus on the quality, not normally measuring by the number of Oscar-nominated or Emmy-nominated as subscribers of Netflix are watching the reality show more than the Oscar-nominated movies. It was said that 6% of viewing hours were from Starz titles, whereas 94% were non-Starz. In addition, Netflix just recently closed deals with DreamWorks Animation, Open Road, The CW, and an ongoing deal with AMC, along with renewed or expanded deals with ACB, NBC Universal, FOX, CBS, Viacom, Discovery, PBS and Sony Pictures.
For the fourth quarter domestic outlook, Hastings thought the DVD subscriptions would decline sharply this quarter, resulting from the price changes. The weekly rate of DVD cancellation is steadily shrinking, and it was expected to shrink more modestly in the future. The margin for domestic streaming would be expected to lower in quarter four, around 8% due to the increased streaming content spend. It was expected to lose money for the few quarters starting from next year. Before the quarter result announcement, analysts had expected 2012 earnings to grow around 38% from 2011. It seems like Hastings wanted to reset the expectations of the investors, analysts, as well as the public.
In its two businesses, the DVD business is enjoying 50% margin whereas the streaming business, even with the scalable, only has an 8% profit margin. As far as I understand, Hastings' strategy is to grow the streaming business with much lower profit margin and to ditch the DVD business. The sudden decision of raising rates for DVDs and unlimited streaming by 60% got a lot of investors who entered the position at $200-$300 level much poorer, and now the further decline in the stock price occurred as lower growth due to growing subscriptions and DVD cancellations. The good thing is the lower subscription acquisition cost as announced, which decreased of 24%. With these current content agreements, I thought it would be enough to attract a sufficient number of new subscribers in the future.
Now the question is whether to take a position in NFLX at this price. The historical valuation shows that it is around 30-40% off from the average five-year valuation. P/E is at 19.6 and P/CF is at 12.2, while the five-year average is 34.8 and 17 for earning and cash flow multiples respectively. With around 25 million subscribers worldwide and a market capitalization of $4 billion, each subscriber would be worth around $160. Netflix can turn out to be a takeover play; however, it is quite unpredictable in nature. In addition, if there are no further strategy moves, the subscriptions number would continue to decrease at least for several quarters to come, and its stock price might continue to suffer from significant fall.
This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.
Just yesterday, the company released disappointed results for the third quarter and has a blurred domestic outlook for the future. The worse hit was in the stock price: It was down further, nearly 35% in a day. In the announcement, the third quarter ended with 21.4 million streaming subscriptions and 13.9 million DVD subscriptions. Unique domestic subscribers reduced to 23.8 million, driven by both higher-than-expected cancellations and acquisitions reductions. However, it still had year-on-year growth in gross additions, acquiring 4.7 million new subscribers, achieving 20% year-over-year growth. And the subscriber acquisition cost declined 24% to around $15. The domestic operating profit was at $120 million, with 15% margin, exceeding the target of 14% due to fewer DVD shipments and fewer DVD subscribers and usage.
For content acquisition, Netflix would end the agreement with Starz in February 2012, which controls the pay-cable rights to movies from Walt Disney Studios and Sony Pictures. In the announcement yesterday, the company said that Netflix Streaming Content Quality is 10 times that of Starz, and Netflix would just focus on the quality, not normally measuring by the number of Oscar-nominated or Emmy-nominated as subscribers of Netflix are watching the reality show more than the Oscar-nominated movies. It was said that 6% of viewing hours were from Starz titles, whereas 94% were non-Starz. In addition, Netflix just recently closed deals with DreamWorks Animation, Open Road, The CW, and an ongoing deal with AMC, along with renewed or expanded deals with ACB, NBC Universal, FOX, CBS, Viacom, Discovery, PBS and Sony Pictures.
For the fourth quarter domestic outlook, Hastings thought the DVD subscriptions would decline sharply this quarter, resulting from the price changes. The weekly rate of DVD cancellation is steadily shrinking, and it was expected to shrink more modestly in the future. The margin for domestic streaming would be expected to lower in quarter four, around 8% due to the increased streaming content spend. It was expected to lose money for the few quarters starting from next year. Before the quarter result announcement, analysts had expected 2012 earnings to grow around 38% from 2011. It seems like Hastings wanted to reset the expectations of the investors, analysts, as well as the public.
In its two businesses, the DVD business is enjoying 50% margin whereas the streaming business, even with the scalable, only has an 8% profit margin. As far as I understand, Hastings' strategy is to grow the streaming business with much lower profit margin and to ditch the DVD business. The sudden decision of raising rates for DVDs and unlimited streaming by 60% got a lot of investors who entered the position at $200-$300 level much poorer, and now the further decline in the stock price occurred as lower growth due to growing subscriptions and DVD cancellations. The good thing is the lower subscription acquisition cost as announced, which decreased of 24%. With these current content agreements, I thought it would be enough to attract a sufficient number of new subscribers in the future.
Now the question is whether to take a position in NFLX at this price. The historical valuation shows that it is around 30-40% off from the average five-year valuation. P/E is at 19.6 and P/CF is at 12.2, while the five-year average is 34.8 and 17 for earning and cash flow multiples respectively. With around 25 million subscribers worldwide and a market capitalization of $4 billion, each subscriber would be worth around $160. Netflix can turn out to be a takeover play; however, it is quite unpredictable in nature. In addition, if there are no further strategy moves, the subscriptions number would continue to decrease at least for several quarters to come, and its stock price might continue to suffer from significant fall.
This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.
