Every quarter, Netflix, Inc. (NASDAQ:NFLX) delivers earnings and the stock goes crazy. Here we are again and things are no different. NFLX stock is up $52 after-hours.
We’ll see what’s driving investors crazy in a second, but first, a preface:
NFLX is a great service and produces great content.
Now that I’ve gotten that out of the way, I’ve just been shaking my head at its valuation and how it produces virtually no free cash flow.
Netflix Earnings
Here are the biggest points from the Netflix earnings report:
- NFLX streaming is where the company excels, as streaming slowly conquers DVD. Revenue increased 34% year-over-year to $1.4 billion. Netflix contribution profit from the segment was $247 million, up 50% from $166 million, and segment margins improved 190 basis points to 17.7%.
- The big number: NFLX added 4.88 million members to total streaming. However, this is for Netflix’s entire streaming division. Things aren’t so rosy on the international front.
- Despite having 19.3 million paid international streaming members, and 2.6 million new additions, that segment’s loss widened from $35 million to $65 million. Q2 is forecast to have a whopping $101 million loss from last year’s $15 million.
- This occurs even as the DVD segment dies the anticipated slow death. Paid members fell from 6.5 million to 5.5 million, revenues declined from $204 million to $173 million, and contribution profit fell from $92.7 million to $84.6 million.
- On a consolidated basis, total revenues increased from $1.27 billion to $1.57 billion, or about 25%, while the cost of revenues increased from $869 million to $1.05 billion. Marketing costs increased from $137 million to $194 million.
- Way down at the bottom line, net income fell from $53.1 million to $23.7 million.
- Free cash flow was negative $163 million.
And the is poised to open Thursday’s trading up — up! — some 12%
Amazingly, despite continuous quarters of low-to-negative free cash flow, the market still was delighted to gobble up $1.5 billion in debt, at a weighted average of 5.7%, split between seven- and 10-year notes.
That boosts Netflix’s cash position to about $3 billion. It has $2.4 billion in debt now. It has billions in off-balance sheet content obligations.
Trailing 12-month net income is $223 million, and Netflix’s market cap is now $32 billion … so, you do the math, and you get a trailing price-to-earnings ratio on NFLX stock of 150.
I remain mystified as to how the market can value NFLX stock like this, but there’s no accounting for irrational exuberance.
Still, is it possible I’m just being obtuse and missing some great growth play at work?
Bottom Line
I feel like a broken record here, but NFLX stock is being priced for perfection for some date that is so many years out, I have to wonder if I’ll still be alive. I think Netflix has done some great salesmanship, in being able to issue some decent bonds that are going to get paid on, even as the company goes nowhere from a cash flow perspective.
At some point, DVDs will go away, and the company will have well more than 100 million global subscribers … and then it’ll raise prices. It’s inevitable. Only when that occurs — and assuming it doesn’t face significant competition from Amazon.com, Inc. (NASDAQ:AMZN), Google Inc (NASDAQ:GOOG, NASDAQ:GOOGL) or a zillion other competitors — will NFLX have sustainable free cash flow.
That’s why it’s investing in original programming, to set it apart from all the other content providers who are able to license the same content.
I don’t get the enthusiasm, but one can’t argue with Mr. Market.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. He is the manager of the forthcoming Liberty Portfolio, has 20 years’ worth of experience in the stock market and has written more than 1,200 articles on investing. As of this writing, he was long AAPL and AMZN. He can be reached at TheLibertyPortfolio@gmail.com.
