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The Daily Walk of Shame: Netflix Share Repurchases

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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.

Fool editor Jim Mueller owns shares of Netflix, but no other company mentioned. Netflix is a Motley Fool Stock Advisor pick. Intel is an Inside Value recommendation. The Fool is investors writing for investors.

Read/Post Comments (7) | Recommend This Article (23)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 28, 2009, at 2:35 PM, LDSGJA wrote:

    I think the company sees low interest rates that cannot last, and that their company is going to skyrocket in growth. And their costs will drop so low once they switch to all streaming in the years ahead.

    However, I think I'd rather see them Debt free than buying back shares. I think share buybacks are a good way to use stagnant cash.

  • Report this Comment On October 28, 2009, at 5:21 PM, Monica109 wrote:

    I agree with jdrumstick that it is best for Netflix to be debt free than to borrow to buy back shares. Perhaps McCarthy is trying to keep the share price up.

  • Report this Comment On October 28, 2009, at 10:49 PM, norman1066 wrote:

    This company is nothing like Select Comfort which, in hindsight, offered an extremely poor value proposition to its cutomers. Those customers completely abandoned the company as the economy grew worse causing them a cash crisis. Netflix on the other hand offers excellent value in comparison to other retail entertainment distibutors. Furthermore, Netflix has a continuing relationship with its customers rather than a one time big ticket purchase (as in Select Comfort's bedding). With its subscription based business model I find it highly unlikely that Netflix revenues or cash flow will drop in the forseeable future. Therefore, I see no reason why a prudent level of leverage would be harmful to any owners.

    If Netflix can continue to grow revenue and profit at anything like the pace they have been on recently then this will look like a very smart move in just a few short years (note their international expansion initiative). One last comment is that I am totally impressed in how this management team has stewarded their (and my) business over the 6+ years I have held my position. I look forward to looking back at this particular moment in another six years.

  • Report this Comment On October 29, 2009, at 3:26 AM, Clint35 wrote:

    I agree this is a bad idea. If the shares were dirt cheap and they weren't planning on borrowing money for the re-purchases it would be great. But shares have gone up quite a bit lately. If they're going to borrow money they should use it for things that will grow the actual business, not for things that will only grow the share price. I was a netflix shareholder for a short time. Management making bone-headed decisions like this one is why I sold.

  • Report this Comment On October 29, 2009, at 5:04 AM, SPFLDnet wrote:

    They may be hearing the distant thudding hooves of hostile intent. Once they shed the weight of DVD related costs, they will look like the defenders of the gas plant in Mad Max.

  • Report this Comment On October 29, 2009, at 8:06 AM, Neoflash1979 wrote:

    I think "modestly" leveraging the balance sheet is actually a good idea and will serve to increase or maintain ROE. To me, it makes more sense to use other people's money to make money than to use your own, especially at current interest rates.

    Of course, borrowing money only makes sense if you dump it in a worthwhile investment. And this is where I disagree with the author. My relatively conservative DCF model places this stocks intrinsic value at around $70 so I think it is a great buy, especially since it dipped the past few days. NFLX has my blessing to continue repurchasing at current levels and to borrow a little bit in order to do that.

  • Report this Comment On October 29, 2009, at 2:09 PM, jswap1 wrote:

    "Obviously, McCarthy knows more about the business than I do."

    I think the main thing McCarthy knows is that one-quarter(!) of Netflix's oustanding shares have been shorted, and he's gonna squeeze them for all they're worth.

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