The subscription-based video-rental specialist reported third-quarter earnings last night. The market hated every word of it, and share prices plunged as much as 39% overnight. We're back to prices last seen in April 2010. Shares have tripled and then given it all back in less than 19 months.
Along the way, the company and CEO Reed Hastings made some big mistakes. In my opinion, they have all been corrected as of last night:
- The Qwikster debacle came and went so fast, all it left behind was a batch of canceled accounts and a dent in Hastings' public image. The defectors may or may not come back after looking for alternatives to Netflix streams in Amazon.com (Nasdaq: AMZN ) Prime or DISH Network's Blockbuster service. The PR damage was Hastings' problem to own and repair.
- In my opinion, he did plenty of that in this earnings call. Netflix lost more subscribers than expected from drastic price changes and the Qwikster thing, but Hastings won't panic and overreact. "The focus for us is in building back our reputation and brand strength," he said. "But that's not through grand gestures, signing some crazy content deal or doing something else. It's the same set of steps that we've been using year after year for the past 10 years in terms of building our brand, which is a steady focus on execution, improving our service quarter-after-quarter."
In other words, regaining those lost customers is a matter of blocking and tackling. You don't change a winning concept. That's exactly what I wanted to hear.
The cherry on top might surprise you? Netflix will stop buying back shares. The buyback always looked like a terrible idea when the money could have been spent on content licenses or heavier marketing instead. That's exactly what will happen now.
Buybacks are often very shareholder-friendly moves. But that's when mature businesses do it. Intel (Nasdaq: INTC ) is famous for a staunch commitment to buybacks and raised dividends. IBM borrows money to buy back shares, and it's an appropriate use of funds.
But Netflix should have been pouring that money into content deals or marketing all along. It may seem counterproductive to stop the buybacks now that shares suddenly look cheap again, but this policy should never have existed in the first place. I'm just glad to see Netflix come to its senses.
It wasn't a slam-dunk perfect report, of course. Cancellations are lingering into October and flattening out in November, leaving lots of rebuilding work to be done in the holiday season. Moreover, the international expansion is slowing down until lessons have been learned from the British adventure. I'd prefer a quicker push across Europe and into Southeast Asia, but that's not what we're looking at here.
Earnings may turn negative in 2012, at least for a couple of quarters, as Netflix builds out its service in the British isles. If that happens, the stock may sink even further thanks to shortsighted traders who miss the forest for the trees.
Netflix could keep earnings in the black if it wanted to, but at the cost of less marketing and fewer content additions, and that's not how you build long-term growth. Need I remind you once again that Netflix has full control over the bottom-line numbers, even if the top line isn't always predictable? So red ink on the bottom line simply means that the company chooses to forge ahead with high-octane growth, even if analysts would prefer stable earning and slower growth.
That's exactly the right thing to do.
Take the right action
So here's the deal. You can stare yourself blind on a temporary loss of subscribers, which will be forgotten a year from now. You can panic over the prospects of negative earnings, which also won't leave any lasting damage. And then you can sell Netflix, locking in all the damage -- real and perceived -- of the past few months. I don't think that's a good move at all.
Or, you can ignore the potential earnings stumbles and look ahead to astonishing results in the future. Don't forget that the Canadian service hit breakeven after just a year, and then think about what Netflix's international numbers will look like in 2015 and beyond.
I was waiting for signs that Hastings still had his head screwed on straight before calling Netflix a buy again. I think it's obvious today that he's as sane as ever, and the shares have become mouthwateringly cheap as well. Mind you, they may still fall further in 2012, but that doesn't make the long-term profit opportunity any less tempting.
There you have it: Netflix is a screaming buy today, right next to widely misjudged camera-chip maker OmniVision Technologies (Nasdaq: OVTI ) and audio specialist Cirrus Logic (Nasdaq: CRUS ) . That's the triumvirate of insane values I'll be choosing from the next time I have capital to spend. They should all be on your buy list as well, or at the very least on your Foolish watchlist in case you're looking for even better starting prices: