After an exciting start to the year, Netflix, Inc. (NASDAQ:NFLX) has spent the last month consolidating its gains. But that could change with the Netflix earnings report on Monday.
For the last month, Netflix stock has generally traded in a range around the $300 level. It’s not hard to see why the rally has slowed down. Tech stocks as a whole have softened. The scandal with Facebook, Inc. (NASDAQ:FB) has cast more scrutiny on internet companies from a regulatory perspective. And some analysts are simply worried about overvaluation again.
But let’s dive further into Netflix. What specifically is impacting the stock as of late? Heading into Netflix earnings next week, here’s what you need to know.
The Netflix Compensation Lawsuit
This week, we learned of some ugly news for Netflix. The city of Birmingham’s pension fund is suing the company for a “rigged” bonus scheme. More specifically, their demand claims that the company’s board: “rigged the compensation process, guaranteeing Netflix officers huge cash payments while misleading investors into believing that these payments were justified by attainment of real performance goals”.
Netflix stockholders should be nervous for two reasons. First, these sorts of compensation scheme scandals tend to linger and linger. The board has to justify their actions, lawyers get involved, activist shareholders try to kick board members out — it all gets ugly. It distracts the company from focusing on more important matters, and leaves shareholders feeling mistreated.
And with good reason. If Birmingham’s claims are correct, it represents a significant mishandling of the company’s duty to owners of Netflix stock. The company is hardly generating profits as it is. Giving the rewards of the business to management, not its stockholders, in a time when the company has a less then perfect balance sheet does not inspire confidence.
NFLX Stock & Spotify
Switching gears, a recent IPO should be cause for reflection at Netflix. Clearly, Netflix and Spotify Technology SA (NYSE:SPOT) are pretty different investing propositions. As I explained recently, Spotify is not yet profitable, and is unlikely to become so in the near future. Netflix, on the other hand, does generate small but positive earnings per share. Additionally, Netflix owns much of its content library, while Spotify is reliant on record labels to license nearly all of its content.
That said, investors will compare the two closest streaming firms out there for valuation purposes. And on that basis, especially if you use price/sales, Spotify looks cheaper. Much cheaper. Spotify is selling at 5.5x its revenues, while Netflix is going for more than 11x.
11x is outright expensive even for a high-growth tech stock, and it is fully double where Spotify is at. Investors should be wary of this heading into Netflix earnings.
And there’s one more wrinkle here. Spotify announced a partnership with Netflix rival Hulu on Wednesday that could disrupt Netflix substantially. Spotify will partner with Hulu, allowing subscribers access to both services for just $12.99/month. That’s a $5 discount versus both services’ combined list price.
How Are Netflix Earnings Looking?
Compensation lawsuits and Spotify’s IPO are long-term drivers for Netflix stock. In the short-run though, most people are probably asking: “is the company going to beat earnings?” If you ask the analysts, the answer is yes.
On Tuesday, Benjamin Swinburne of Morgan Stanley raised his Netflix stock price target from $275 to $350 citing strong pricing power and more growth in Asia. Both seem like reasonable arguments. Goldman Sachs concurs. Their analyst bumped the price target from $315 to $360 ahead of earnings. While showing concern that new subscribers may be soft due to a weak new releases slate, they felt that the company is achieving benefits of scale and global distribution that outweigh the content concerns.
As for what to look at in the earnings release, I expect investors to be focused on the international numbers. 2017 was the first year that the international division produced an overall profit for the year; Netflix has long done better in its domestic market. But the company’s brand is growing quickly overseas. As I’ve said before, the company’s large library of locally-produced content for other languages and cultures gives it a big leg up versus other US-focused streaming services.
In addition, focus on the company’s operating margin. Netflix management has described it as their main profit metric. It rang in at 7.2% last year. Management has guided to 10% for this year. Moving toward that figure would prove that the company’s bet-the-farm on content strategy is paying off. A shortfall, however, would likely lead to Netflix stock taking a dive.
Bottom Line for Netflix Earnings
Last time I wrote about Netflix stock, the price was on fire and I explained why. Since then, it has cooled down considerably. But mark your calendars. On Monday, Netflix stock could get going again. If the analysts are right, Netflix is ready for its next big run higher.
By all means, take advantage of the technical opportunity to enjoy the stock breaking out. Particularly since tech stocks as a group are due to rebound. But don’t lose sight of the bigger picture.
NFLX stock still has plenty of risk factors — valuation as a big one — and the entry of Spotify to the market is likely to cause Netflix headaches over time.
At the time of this writing, the author owned FB stock, and has no positions in any of the other aforementioned securities. You can reach him on Twitter at @irbezek.
