Netflix Survives at the Pleasure of the Studios

Netflix (NASDAQ:NFLX) isn’t long for this world. But that doesn’t mean the stock still can’t go to $300.

NFLX shot up $42 the day after reporting earnings that, upon closer examination, were terrible, so the market clearly has no problem taking the stock where it shouldn’t logically go.

Numbers don’t lie, and the numbers in the report are not good. But CEO Reed Hastings continues to do a great job at distracting investors from the real story.

The market loved the 2 million new domestic streaming subscribers for the quarter, and 5.7 million net additions YOY. The segment’s contribution profit nearly doubled from $72 million to $131 million, and on $2.7 million less in marketing expenses.

These results were assisted by the 4 million new international streaming subscribers, which cost Netflix an additional $75 million to acquire, but only generated $100 million in new revenue. So overall, international streaming losses went from $103 million to $77 million. It’s headed in the right direction, but that’s still a drag.

Meanwhile, domestic DVD is dying, as subscribers continue to fall, dropping from 10.1 million in Q4 of 2011 to 8 million this past quarter, resulting in a decline of $30 million in profit.

Overall, Netflix saw a whopping net profit of $2.69 million!

All of this came at the expense of operating cash flow, and that’s a number investors need to watch. Q1 saw negative operating cash flow of $12.1 million, which follows Q4’s negative $16.2 million. This is a far cry from Q1 of 2011 when Netflix generated $116 million in OCF.

But none of this stopped Hastings from proclaiming that the quarter’s results proved the success of the company’s foray into original programming with House of Cards.


There is no way anybody at Netflix can quantify how many subscribers came to Netflix purely, or even partially, as a result of this new program. Think about it. When you sign up, is there some survey that asks why you’re signing up? Is there some special website to sign up because you saw an ad for the new show?

I’ve spoken to executives at HBO and DirecTV (NASDAQ:DTV). Even they admitted to me that there was no way to tell how many people sign up for the service as the result of exclusive programming — not even when The Sopranos was hot.

Netflix has other problems coming down the pike. The company has $2.5 billion in content obligation payments due this year. It has $1 billion in cash and investments. Somebody want to tell me how the company will come up with $1.5 billion in cash when it generates negative operating cash flow every quarter?

So what will happen? The studios will have a few choices.

If the content is exclusive to Netflix, they’ll first shop it to Amazon (NASDAQ:AAPL) and Apple (NASDAQ:AAPL) to see if they’ll bid competitively for it. If not, they’ll renegotiate the price down for Netflix to keep it.

If the content is not exclusive, they’ll also renegotiate down. Why? Because Netflix exists for one reason, as far as the studios are concerned. Like a vampire, the studios feed on others, but must keep their prey alive to ensure a constant supply of blood.

In this case, Netflix is the blood source.

Netflix will never have large amounts of cash. It will never maintain any significantly positive free cash flow because the studios will suck it all out. And that’s because Netflix has no bargaining chip against their prices — it needs the content, or it ceases to exist.

So every time you hear about some sucker putting up some debt capital for Netflix, you should laugh, because that debt is never going to get paid back. And it’ll go straight into the pockets of the studios.

Netflix will be out of cash by year-end, unless the vampires leave it with enough blood to continue operations. Content providers want Netflix weak, but alive — just profitable enough to generate cash so the studios can take it.

Which is why you don’t want to own Netflix, and at some point, you’ll want to short it.

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. However, he does suggest you own Walt Disney (NYSE:DIS), because you want to be with the vampire — not the victim.

Article printed from InvestorPlace Media,

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