This Motley Fool series examines things that just aren't right in the world of finance and investing. Here's what's got us riled today. If something's bugging you, too -- and we suspect it is -- go ahead and unload in the comments section below.
Today's subject: I just had a chance to read the transcript of Netflix's (Nasdaq: NFLX ) earnings conference call from last week, and one statement made my jaw drop.
As part of his prepared remarks, Chief Financial Officer Barry McCarthy said, "Last quarter, we announced plans to modestly leverage our balance sheet to fund future share repurchases, and that remains our objective." In answer to a question posed by Barton Crockett at Lazard Capital Markets, McCarthy elaborated:
To rephrase the question, I think they're asking: "Would we be prepared to buy at current levels?" And the answer is, yes. And if the question were: "Why?" The answer is because we think it's a good value, obviously.
Why you should be indignant: Obviously, McCarthy knows more about the business than I do. However, as a Netflix investor, its plans to use debt for share repurchases scare me.
Select Comfort (Nasdaq: SCSS ) infamously used debt to fund buybacks, even as the housing bubble burst and its market for high-priced beds disappeared. Dollar Thrifty (Nasdaq: DTG ) also used debt to fund share repurchases as the credit bubble burst, driving its rental business ran into a rough patch. As a result, both companies came this close to bankruptcy. I'm sure they're not the only examples.
According to Mr. McCarthy, since Netflix's share repurchases began in the second quarter of 2007:
- The company has purchased 17.8 million shares for $545 million, which works out to $30.62 each, on average. Sweet.
- In the last quarter, it bought 3 million shares for $130 million, at $43.33. Not as good, but still decent, considering the current price.
- It has since purchased a further 1.2 million shares, but that must have been at prices ranging from $44 up to $49 or so. Not as happy-making.
Danger, Will Robinson!
See what's happening? As the market bids the share price higher, Netflix is getting less bang for its buck. As a shareholder, I require the company to return value to me. By paying higher prices for the shares, the company is doing less of that.
Given its modest amount of share-based compensation, Netflix is not forced to repurchase shares to control excessive dilution, unlike companies such as Cisco (Nasdaq: CSCO ) or Intel (Nasdaq: INTC ) . So why does Netflix management feel it must still repurchase shares? The authorization to repurchase shares does not obligate the company to do so.
The current price implies that the market expects Netflix to grow net income by about 35% per year going forward. Yet over the past three years, the company has grown net income by an average of 15.9% per year. Unless it can really ramp up that rate going forward, I have to disagree with Mr. McCarthy's characterization that the shares are "a good value" today.