Netflix, Inc. (NASDAQ:NFLX) reported second-quarter earnings on Monday afternoon. In many ways, the numbers look great, but the Netflix stock report wasn’t without a few bumps.
Overall, the business is doing quite well, but the costs of operations are ridiculous and the valuation of Netflix stock is even more so.
Subscribers and Costs Grow
More than 4 million new domestic subscribers were added year-over-year and 1 million over the quarter. Contribution profit for the segment leapt from $414 million to $560 million, which was about a 35% increase. The profit per paid subscriber also rose about 23%, from $9.01 to $11.13.
However, the marketing cost per new paid subscriber was up by more than 55%, from $17.55 to $26.30. Thus, Netflix is spending more money per new subscriber to get them onto the service, and that’s not a good thing. Still, the domestic business is arguably healthy, with over $1.16 billion in contribution profit.
International subscribers have really caught on, apparently. I confess surprise that there are now 48.7 million paid memberships, up from 33.9 million last year. I just didn’t think other cultures had the same viewing habits as Americans.
Mind you, Netflix stock has to deal with the fact that international operations have only been profitable one quarter, but the good news is that the loss has narrowed significantly, to the point where it is only 27 cents per subscriber. That’s way down from last year’s $2.04 and a far cry from the second quarter of 2015 when it was $4.25.
So international almost broke even this quarter, with a loss of $13 million, and is still positive by $29 million for the year. It appears that the idea of Netflix is catching on internationally, as it only took $10.84 of marketing per subscriber, so word is spreading and lots of people are signing up.
DVD continues to shed members at a rate of about 200,000 per quarter. There’s still $62 million of juicy profit there, and $122 million for the first half of the year, and figure $240 million for the year. Expect this profit to decline by about $40 million per year until it’s all gone.
After backing out all the other expenses, Netflix stock generated operating income of $127.8 million, about half of Q1, still up about 28% YoY. Net income was $65.6 million, bringing the FY total so far to $244 million.
As for cash flow — it’s a mess. Netflix stock burned through $534 million in cash this quarter, and $878 million YTD. That’s a run-rate of $1.76 billion, ahead of last year’s $1.474 billion. So with $2.16 billion of cash on hand, NFLX has about 15 months of cash left.
Except it’ll go the debt markets again, and Netflix said it will be free cash flow negative “for many years” — which should tell investors a couple of things.
First, the implication is that once the cash is used to create content, that the content itself has value that is multiples of the cash spent to create it.
Bottom Line on Netflix Stock
That is probably true, in a messy way. The content exists on Netflix and that content attracts subscribers. Over time, those subscribers pay money and may recoup the costs of producing the shows, and may even provide more. One might also expect that, at some point, Netflix may license its original content to other streaming, pay-TV, cable, or networks.
One analyst says that Netflix earns a dollar in revenue per dollar of net content costs, which is less than what traditional content creators are making. He suggests that there is thus more money to squeeze out of the content. The analyst essentially said that Netflix content is worth $11 billion, or about in line with revenue.
So if the content is only worth $11 billion, why is the market valuing it at $77 billion, or 7x revenue? Walt Disney Co (NYSE:DIS), which arguably has the best content in the world, is valued at 3x.
Anybody else see a wicked disconnect?
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
