Netflix, Inc. (NASDAQ:NFLX) appears to have turned an important corner in regards to streaming profitability with its fourth-quarter earnings release. And that’s one of the most important pillars in any argument about whether to buy NFLX stock.
Cash burn is of serious concern, but the other big note about Netflix earnings for the quarter is that its original programming just keeps getting better and cements its long-term proposition. NFLX is not the kind of stock I would presently put in my forthcoming stock advisory portfolio, The Liberty Portfolio, but it might one day be if the valuation got reasonable.
First, let’s look at the important numbers here for Netflix earnings. Then, we’ll analyze where NFLX stock sits for potential buyers.
Netflix Q4 Earnings Recap
Much of the good news was driven by better-than-expected growth in subscriptions. NFLX added 7.05 million net new members globally, against its own guess of 5.2 million … and represented the largest quarter of additions thus far.
Of these, 1.93 million NFLX subscribers came in the U.S., blowing away the expectation of 1.45 million, and up 25% year-over-year. The same good news came across internationally, which grew by 5.12 million versus the 3.75 million forecast, and up 25% as well.
What’s important with these additions is how they contributed to revenue and operating profit. U.S. streaming revenue grew by about 27% to $1.4 billion. Contribution profit leaped from $379 million to $536 million. International streaming is seeing improvement, with the rate of revenue increases outpacing the rate of expense growth, so contribution loss improved from -$104 million to -$66 million.
DVD memberships continue to fall … but we all pretty much knew that.
What I Really Liked About This Report
I have to point out a very significant item from this batch of earnings. Netflix content has always been good to great, with very few duds. The content continues to impress, but it impresses on a very specific level.
The content Netflix is producing is highly targeted. It has been reviving series that used to be watched by millions like Gilmore Girls and Full House. It is offering comedy, which always does well. It has animated stuff for kids. It is offering intelligent, high-brow, and indie-sensibility-driven original series. Its films are a wise combination of popular culture and weird/European/indie (The Discovery).
Good on Netflix.
By offering the indie/European-style content, it enhances its appeal to European subscribers. I’ve always been a bit skeptical about the ability for Netflix to have broad and profitable appeal in non-English speaking countries. Yet it just might have more success there than I thought.
The fact is that NFLX is the first-mover for on-demand streaming content in most countries. While there is a cultural obstacle to overcome, in that most cultures want to see its own faces in the content it consumes, its better to have content at all without those faces than no content. That is what may help Netflix more than I anticipated.
Still, we need to tackle some financial issues.
Problems With NFLX Stock
Original programming is expensive, and we’re seeing this reflected in the P&L and the cash flow. Netflix raised a billion dollars in debt in Q4, but once again, I confess surprise. I thought that debt would easily cost it 10% or more, but they managed to price it at only 4.375%. This is huge. It means raising debt to fund original programming will not be the cost suck I expected.
We can’t sugarcoat the fact that Netflix burned $639 million in cash in 2016. The $1.83 billion of liquidity that Netflix has will fund $1 billion in new content, and another year of cash burn, but then it’ll have to raise cash again. I don’t think the company could get away with another NFLX stock offering because shares are controlled by momentum players now. But I’ve been wrong before. Clearly, debt remains an option.
And now, a final thought on valuation.
The market does what the market does. Yes, I think Netflix stock is overvalued. What might it be worth? Well, we finally have HBO data to compare it to. HBO’s operating income for the trailing 12 months was just about $2 billion. Time Warner Inc. (NYSE:TWX) had TTM operating income of $7.2 billion. If we thus assume that HBO is about 30% of Time Warner’s value (market cap of $73 billion total), then HBO is worth about $21 billion.
Including after-hours pricing on NFLX stock, Netflix is valued at $61 billion. I don’t see that as a fair valuation. However, I do think it’s fair to value Netflix stock at about the level of HBO.
It doesn’t have the library HBO does, but it has more pricing power, since it’s already about a third cheaper than HBO.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, has no position in 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.
