Before You Bail on Netflix

In a case of perfect timing, Netflix (Nasdaq: NFLX  ) CFO Barry McCarthy joined CEO Reed Hastings at the Barclays Capital 2010 Global Technology Conference yesterday.

The stock had taken a hit earlier in the day after McCarthy's resignation was announced, and here he had the perfect opportunity to defend his decision.

"I'd like the opportunity to run my own business," he explained.

In other words, he's not running away from some accounting scandal that's about to blow up. It's not as if he sees the company's model peaking. Despite selling a ton of stock lately -- something he justifies as a way to strike out on his own without having any financial concerns -- he still owns more stock than he has sold.

He has been talking to Hastings since 2004 about his desire to run his own company, and the timing seemed right.

"The opportunity to go out on top while the business is killing it is rare," he says, before setting investors at ease. "There's nothing that I know -- that you don't know -- that would cause you to be sleepless about your position in the stock."

He also let out a nugget that's been making the rounds.

"I'm not sure you'd want to short this quarter," he warned.

Going out with a blowout
Netflix has been historically conservative in its guidance. It had beaten Wall Street profit targets for nine consecutive quarters before coming up short in its latest report.

Had analysts finally caught on to Netflix's fiscal performance? Was Netflix's stance to grow subscribers and ink costly streaming deals -- while tactfully savvy -- about to turn low-balling analysts into Wall Street clairvoyants?

If it wasn't just lip service on McCarthy's part, his comments can be interpreted as either a big win on the bottom line or Netflix barreling past its guidance of closing out the year with as many as 19.7 million subscribers.

Can Netflix actually top 20 million couch potatoes by year's end?

Other juicy tidbits
Hastings and McCarthy also tackled a few questions that provide some interesting insight into the company.

Netflix feels that average revenue per user will continue to trend lower, despite next month's price hike. He sees consumers continue to gravitate to its $7.99 streaming-only plan.

This doesn't mean customers have kissed optical discs goodbye. Hastings still sees a record number of DVD shipments this quarter, though that is largely the result of Netflix's fast-growing audience base.

Netflix also addressed next year's pending renewal of its deal with Liberty Starz (Nasdaq: LSTZA  ) . The original deal was inked in 2008, when streaming was just a novelty. Now that more than 11 million of Netflix's 16.9 million subscribers are streaming -- through a growing range of devices -- Starz is likely to demand a headier payout.

If studios think they're going to bully Netflix around to strike content licensing deals at top dollar, they may be in for a rude awakening.

"There is no one piece of content that we have to have," Hastings claims.

Netflix also discussed net neutrality, especially as Comcast (Nasdaq: CMCSA  ) and Level 3 Communications (Nasdaq: LVLT  ) are locked in a war of words over peering arrangements.

Netflix isn't concerned, as long as there's public support for open access. After all, if any broadband provider ever cuts off access to Netflix's content-delivery partners, folks unable to stream their Netflix videos will be complaining to their local politicians.

It's also not overly concerned about tiered broadband pricing. If stateside access providers begin metering bandwidth -- something that AT&T (NYSE: T  ) is already doing with its smartphone data plans -- Netflix still feels that consumers will be drawn to the value proposition of streaming video. Its early success in Canada, where Netflix expects to be profitable within a year of the streaming service's launch, helps validate that position given Canada's tiered Internet pricing plans.

Yes, streaming is what consumes Hastings these days. He admitted to spending 98% of his time working on streaming and just 2% on the DVD aspect of his business. Every studio has different expectations and concessions to ponder.

Most studios have warmed to the 28-day waiting period for Netflix on new DVD releases to win pricing and content concessions elsewhere, though Disney (NYSE: DIS  ) and Viacom's (NYSE: VIA  ) Paramount remain the two major studios that are holdouts on that end. Then again, Disney just broke in a 15-day waiting period on television shows before Netflix can begin streaming them, so maybe Disney will be next to be won over by the four-week freeze on new DVDs of theatrical releases.

Yes, Netflix will miss McCarthy, but the company appears to be in the best shape of its life.

Will Netflix be higher or lower a year from now? Share your thoughts in the comment box below.

Walt Disney is a Motley Fool Inside Value recommendation. Walt Disney and Netflix are Motley Fool Stock Advisor picks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Longtime Fool contributor Rick Munarriz has been a Netflix shareholder -- and subscriber -- since 2002. He also owns shares in Disney. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


Read/Post Comments (17) | Recommend This Article (12)

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 December 09, 2010, at 10:26 AM, Pandorabelle wrote:

    Good that they don't need any "one piece of content" because they won't have any.

    NFLX has NO MONEY...and nothing to barter with buy a rapidly shrinking bottom line. It's over.

    You can fact the facts or join the ostriches.

  • Report this Comment On December 09, 2010, at 10:27 AM, louginger wrote:

    Sorry, CFO leaving when and how he did still does not bode well.

    This business model does not hold up given everything that is happening in this space. A P/E of what? This company simply can not grow into that number. I'm newly short and plan on staying there through 2011. It should be a rollercoaster, BUT, as with rollercoasters, the end of the ride is at the low point!

  • Report this Comment On December 09, 2010, at 11:25 AM, verylargelarry wrote:

    Hilarious.

    A bit of history for louginger and the others.

    I'll listen to the chatter predicting Netflix's demise for another four years (its been held 25% short all that time - huge short interest!) happily. Drives my holding higher when you eventually have to cover.

    Here's an innovator, galvanized by years of risk, leading a new sector they invented, driving toward significantly lower costs of business to meet the war against absolutely no new competitors, all of whom are scurrying to catch up.

    It is supported by an exploding number of new subscribers (quarter after quarter after quarter) who join what can only be described a happy, loyal group who vote (96% of 'em anyway) every month to enjoy the company's service.

    In a market where it is the ONLY company showing customer increases, they are up 50% yoy. Who do you think has the content providers' attention - Netflix (their biggest paying customer) or another shrinking cable provider or recently bankrupted rental store chain????

    Don't step in front of this stock. The company has a history of executing to get to the top. Ignor that history at great peril.

  • Report this Comment On December 09, 2010, at 11:31 AM, verylargelarry wrote:

    Hilarious.

    Netflix was down this morning. Nearly 2% when I began writing my comment above at about 11 am EST.

    Position turned positive as I typed, Up $700 while I typed. Wish I typed slowwwwer.

    Some days it really is alllllright!

  • Report this Comment On December 09, 2010, at 11:42 AM, louginger wrote:

    verylargelarry may be of little brain.

    Sorry, they are experiencing turnover, and, shared (read unpaid) usage.

    with a P/E of 71+ exactly just how much growth do you see happening to grow into that number? Even with healthy operating leverage working for them extremely tough to do.

    Lets say they hit 20 million subscribers by year end...where are the next 20 million subscribers (NET) coming from? Canada! You betcha! HA! Give me a break it just ain't there.

    That is what I find hilarious.

  • Report this Comment On December 09, 2010, at 11:54 AM, Pandorabelle wrote:

    Littlebrainlarry - They show increases by including FREE GIVEAWAYS in their numbers...but don't tell you! They will lose STARZ....no one want DIS...and they have NO MONEY. They can't afford to update and renew content.

    Invented the sector? That would be funny if it were not so ignorant. They license content and rent DVD's. Now they want to jump on the streaming bandwagon and say that is what they do primarily. No friends---that's what Hastings wants you to THINK they do...that's what he is trying dessperately to conquer...but they have NO MONEY...and no platform....and starting soon they will be charged for bandwidth---forcing them to pass it on to subscribers. Netfilx is scrambling...and the price action you see on a teeny float is the MMs moving the stock at will---until it implodes.

    The least you could do is share your drugs.

  • Report this Comment On December 09, 2010, at 11:55 AM, louginger wrote:

    OK....some more info

    if you think about how much Netflix is typically charged for the royalty [for streaming], as opposed to just sending [by] mail, it's about 40 cents a movie. If you take that number and now take in the streaming costs, which are about five to six cents per 1 gig transfer -- you're thinking about 50 cents per movie. If [a customer] has an $8 [per month] plan, anybody who [streams more than] 16 movies a month is already a non-profitable customer.

    How does that work out to a roaring growth in profits...this model has some serious problems.

  • Report this Comment On December 09, 2010, at 12:37 PM, verylargelarry wrote:

    Last comment for me, and I will avoid the name calling...

    Lou, suggest you convert over to making your judgements based on free cash flow/earnings. Its a much more important way of evaluating a growth company.

    If one follows your little mathematical excercise one can easily see how Netflix cannot possibly show a profit yet something in its history persuades me otherwise. If its losing money allowing 16 streaned movies a month and only charging $8, how did they survive the 2 years they have allowed 16+ streamed movies and charged no extra fees? Under your model, they bled losses, but a review of the reports disproves that.

    Point is this - 1) You have no insight about the confidential contracts Netflix has entered into regarding costs, billing or any other aspect other than public releases. 2) you are seeing troubles in a troublesome area previously navigated by this team.

    Sure fights history, doesn't it. A HUGE MOVER like Netflix can continue higher. I feel they must dominate their competitive space. Show strong vision. Demonstrate significant and improving growth and financial well-being for a significant period.

    Netflix is an exemplar on all counts.

  • Report this Comment On December 09, 2010, at 12:38 PM, verylargelarry wrote:

    PS.....Netflix is up another $2 from my earlier mark. Ain't love grand?

  • Report this Comment On December 09, 2010, at 2:04 PM, hackman2007 wrote:

    louginger, the process is called economies of scale. Since Netflix is so large at some point their costs will be minimal. The costs are not fixed per number of output. Also keep in mind that not every user is going to stream 16 movies in a month. Right now, I'm not even using the streaming portion.

    And another point, Netflix has been around since 1997, which was before the dot-com boom. If they were truly not profitable, they would either a) crash and burn/close or b) raise the subscription costs. Before you mention the $1 increase in the $8.99 plan, keep in mind that Netflix is planning to have more streaming and eventually cut down their DVD by mail service.

  • Report this Comment On December 09, 2010, at 11:26 PM, IronRnr wrote:

    Gentlemen (& Ladies, too) -

    You are right on several counts:

    1 - The next 20M customers will not come from Canada. There are billions of people in this world and many other countries beyond the shores of North America. How does that line go from Die Hard, "Alexander wept as he overlooked his domain for he realized there were no more worlds to conquer?" I suspect Netflix will expand to other countries long before it books the next 20M customers ... and it's a long way from conquering the world. That spells huge opportunity and is what drives R&D costs and growth. Movies & entertainment are a chief export of the U.S. With a broad selection of all genres (Bollywood even), Netflix can easily span the globe. What's one more server farm? “One million” (with little finger pointed) server farms? This opportunity is what drives the multiples so high.

    2 – It’s true that Netflix will lose money on people who watch more than n movies per month. I hear this comment from lots of people, but none of them can watch that many movies in a month. It’s a theoretical question. They never tried. Have you ever tried? On a regular on-going basis (more than a month or 2)? It's hard. I tried it ... and I quote too many movies, as a result. For the vast majority of people who have families, friends, jobs, & other commitments this is just not sustainable. (Reed, my movie watching is around 5-10 per month, really.)

    3 - "..., but somebody will still watch that many!" Yes, there still will be people who take advantage of this opening. Fringe cases exist in every market. However, Netflix is metrics driven, has a long history of A/B testing, and is not afraid to adjust pricing to fit the changing world. Despite its size, the firm remains incredibly nimble ... and maybe the challenge to watch unlimited movies functions as an attraction for more profitable customers. How does that ad go, “We’ll make more?”

    4 – Shares are overpriced. They are mispriced, for today. This is just as true now as when the shares were $10. There is no argument here. That’s Hollywood … I mean … That’s the market. Actually, it’s both. The ebb & flow is as normal as the tides on all shores. Go ahead. Try to time it if you like. I don’t have enough time to time the market or to watch 16 movies per month.

    This all ignores the bigger picture on the TV. Netflix is making money, investing it wisely (buying back shares, investing for the future, etc), and still demonstrating hyper growth. They took on industry giants, escaped their clamping jaws, only to watch them implode … like chomping on a scuba tank. If Netflix had “One billion dollars” of debt, then I’d be concerned.

    Netflix plays in the space of the long tail. This is why no single movie, studio, or new release is of concern. While virtually all other competitors are stumbling over themselves to get the latest release, Netflix is cashing in on the 98% of the space on the graph under the long tail. The competition doesn’t realize it, but every commercial citing “28 days” is an ad for Netflix. It’s like Madonna & PT Barnum said, “any advertising is good advertising.” The studios actually love what Reed is doing as he is able to generate revenue for them in a space where they didn’t have the marketing bandwidth. Reed has been sharing these secrets for years, but the volume is too high in the fight over the 2%. It’s a classic win-win.

    Speaking of classics, the hero will ride off with the girl into the sunset. That’s why we watch movies.

  • Report this Comment On December 10, 2010, at 3:52 PM, Pandorabelle wrote:

    Larry, I apologize. The name-calling was rude and unnecessary. NFLX was a huge mover historically with an entirely different business model....DVD's. They do not own anything or a platform to stream from. they will have to PAY for everything and they have next to no free cash flow!

    Iron, I have to disagree on the bigger picture. NFLX is not making money...and they have no proprietary service to barter deals with to draw in money. All they have is a name...which will be insufficient in the new streaming landscape.

    The share price has been manipulated by the HFT-bots in hegde funds and institutions to push the price higher and higher on a tiny float....(sshhhhhh....no one has mentioned the SEC's 3-yr invesitgation into FRAUDULENT insider trading activity...including Fidelty!)

  • Report this Comment On December 10, 2010, at 3:53 PM, Pandorabelle wrote:

    PS....Fidelity....majority owner of Netflix!!!

  • Report this Comment On December 16, 2010, at 5:30 PM, PatW333 wrote:

    Sundolly,

    Time will tell if you are a prophet or a fool but I gotta tell you that it may be time for you to let this go.

    Is it really necessary for you to answer anyone who has a different opinion stating the same things over and over?

    How about taking a deep breath and relaxing?

    Time will be the judge.

  • Report this Comment On December 18, 2010, at 4:58 PM, rfbraunjr wrote:

    I'm a newbie as far as investments go, but me and my family just love Netflix. This will sound really simpleminded to all the pro's out there, but anytime I can browse through classic movie listings and have them playing within a minute (with no commercial interuptions), you've got me for life.

    I also think that 20 million is a small percentage of Americans (6 or 7%) and that there is plenty of room to grow. The children in my house are hooked as well as my wife. This service is worth more than the 7.99 we are charged.

    Imagine if Netflix could sign up 6% of China! 72 million? Wow!

  • Report this Comment On December 18, 2010, at 11:46 PM, FoxWise wrote:

    This is the big year for Netflix, the tipping point. BlueRay disc players are the big Christmas gift, and most come with Netflix streaming access built in.

    Up till now, only dedicated movie buffs and networking geeks have been willing to go through the trouble to get streaming content from Netflix; now it is easy enough for everybody.

    Just like email, just like Facebook, there comes a point where Everybody has it. That is 2011 for Netflix.

  • Report this Comment On December 19, 2010, at 5:14 PM, Redvineeater wrote:

    For 3 months I have had one thing or another wrong with Neflix's service. Of course I have spoken with numerous customer care ppl, however I find each of them have a different impression on how to help. I have never talked with a tech rep to resolve any problems. It's as though they are perfect and it's all my fault Im having problems. I have notified my Comcast tech to come to the house, per Netflix's customer service rep, to have more speed added to my service. I have downloaded netflix from other sites, but it's all the same...after I enter my password and ID, it throws a picture of a lock up by the browser strip on Internet Explorer and there's where I stay. I have spent two days trying to figure out what is wrong and then I got to this sight that tells me I'm not the only one. This method of their maddness to make more money could be that they want you to buy into their new idea which is the HTC HD7. This seems highly likely to me. I feel all isn't lost if I can't get on the internet to watch a movie. I don't know what their concept or plan is. At the present time, I am more than angry over this.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1394629, ~/Articles/ArticleHandler.aspx, 9/2/2014 1:09:20 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement