Netflix, Inc. (NASDAQ:NFLX) CEO Reed Hastings certainly did his best to soothe shareholders worries after the company posted disappointing Q2 results. But it was all for naught. NFLX stock plunged more than 14% in after-hours trading on Monday evening, with investors unable to get past the significant shortfall of subscriber growth.
All told, NFLX only signed up 1.7 million (net) new subscribers last quarter, missing Netflix’s expectations of 2.5 million new members and the market’s outlook for 2.1 new subscribers.
It’s a bit of a moment of truth for owners of Netflix stock. Do they really believe the company is just in a state of overhaul right now and will come back in 2017 (or even late 2016) better than ever? Or is this a sign of the beginning of the end of Netflix’s dominance in the on-demand space?
Unfortunately for NFLX stock holders, it’s looking more like the latter.
Netflix Earnings
For the second fiscal quarter of 2016, Netflix earned 9 cents per share of NFLX stock on $2.10 billion worth of revenue. That was better than the year-ago bottom line of 6 cents per share, and the top line grew an impressive 28% from last year’s sales total mostly thanks to overseas growth. Earnings estimates for only 2 cents per share were handily trounced.
In Hastings’ letter to NFLX shareholders, he explained:
“We think some members perceived the news as an impending new price increase rather than the completion of two years of grandfathering. Churn of members who were actually un-grandfathered is modest and conforms to our expectations,”
The market wasn’t swayed, though, effectively doubting the company’s future will be as bright as Hasting’s suggests it will be now that the service’s competitors are getting very, very good at the service Netflix pioneered.
Drilling Deeper
While the top and bottom lines for Q2 offer a glimmer of hope for shareholders willing to see the glass as half-full rather than half-empty, a closer look at some of the lines paint a more concerning picture.
Case in point? Marketing costs were up 32% on a year-over-year basis. Technology and development spending grew 34%. SG&A expenses swelled a little more than 44%. Current content liabilities grew 26% on a year-over-year basis, while non-current content liabilities were up 39%. Free cash flow was negative again … -$254 million. Netflix is spending a lot more, and committing to a lot more, to drive just a little more revenue.
Fans and followers will be quick to argue that the company’s expansion and original content isn’t cheap, but will be worth it. Reed Hasting’s himself made a point of saying:
“We continue to expect to turn around break-even on a net income basis in 2016 and to generate material profits in 2017 and beyond.”
It sounds great. But words are easy to say. With Sony Corp (NYSE:SNE) Vue, Sling TV, Amazon.com, Inc. (NASDAQ:AMZN), Hulu, CBS Corporation (NYSE:CBS) All Access, and more ODV players (some of which with broadcast TV options) all forcing one another to come up with something incredible, Netflix is finding itself on the losing end of too many consumer either/or debates,
Bottom Line for NFLX Stock
Supporters and owners of NFLX will defend the company by pointing out the big spending will soon subside and then the company will start to widen net margins in a big way.
Maybe to some extent that will happen.
But this is an industry built on bidding and marketing. If Netflix doesn’t pay for the next great content, somebody else will. And much of its competition not only makes their own content the way NFLX doesn’t, but they have wide distribution channels for that content, making their cash outlays more cost effective.
Netflix can do the same. In fact, it already has. Its app will soon becoming available on some Comcast set-top boxes, and it’s going to be streaming the new Star Trek TV series to overseas subscribers almost as soon as they’re aired on CBS All Access.
These cross-channel deals are all relatively new to Netflix, though, while they’re not new to names like Sony and the media companies running Hulu.
Netflix stock owners may want to start digesting the possibility that the company won’t be able to stop bleeding cash if it wants to remain competitive, and clearly competition has already started to chip away as its subscriber base.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
