We sent a company down the daily Walk of Shame earlier this week. In my eyes, it had no business feeling guilty.
On Wednesday, fellow Fool Jim Mueller lambasted next-generation movie maven Netflix
Here's the buyback history that makes Jim shoot steam out his ears:
Shares Repurchased |
Amount Paid |
Cost Per Share |
|
---|---|---|---|
Since Q2 2007 |
17.8 million |
$545 million |
$30.62 |
Q3 2009 |
3 million |
$130 million |
$43.33 |
Q4 2009 to date |
1.2 million |
Not disclosed |
$44 to $51* |
Source: Netflix conference call. * Based on share price range from Oct. 1 to Oct. 22.
Management calls this a good investment; Jim disagrees with a passion. Netflix is getting less bang for every buck invested -- and is borrowing money to do more of it. Now let me show you why this is a good idea.
Always look on the bright side of life
Like Jim, I'm a Netflix shareholder, so I want the company to do the smart thing just as much as he does. It would be awesome if Netflix could buy back shares for pennies on the dollar, especially if we were free to sell our shares for a sizable gain at the same time. But that's not how the market works. When you think stocks are cheap, you buy. When you think they're expensive, you sell.
Yes, Netflix shares have risen a lot lately. As I see it, though, if the company is still buying the stock with gusto, then its managers must believe in further gains ahead. Granted, business leaders don't have a crystal ball and do make errors in judgment. But just because Dollar Thrifty
Other bets like this have worked out very well. IBM
IBM is still buying back shares, even at today's higher prices. Why? Because IBM's management doesn't think it likely that the shares will be significantly cheaper anytime soon. And that's exactly how Netflix CEO Reed Hastings feels about his own company, too.
Hastings is not mortgaging the house to buy poker chips. $100 million will come from new revolving credit lines with Wells Fargo
"The consensus Street estimate for subscriber growth and marketing expense is too low," if you ask Hastings. "And the consensus Street estimate for operating income and EPS growth is too high." And that brings me to ...
Earnings? We don't need no stinkin' earnings!
I believe that for companies like Netflix and VMware
In particular, the problem with applying traditional earnings models to Netflix is that the company's management isn't just out to maximize short-term earnings, you see. Instead, it tries to balance subscriber growth -- which translates into revenue growth -- and earnings against marketing expense. The current goal is to keep the operating margin close to 10%. In the past, higher marketing expense has resulted in faster subscription growth, but it has also pressured net income.
As you've already heard, Hastings himself thinks you should care at least as much about subscriber growth as you do about earnings growth. Looking in the rearview mirror, annual subscriber growth stands at 28% today -- and the company is taking steps to boost that much higher. So as I see it, the metrics that matter tell me that Netflix is somewhere between fairly valued and darned cheap. If I could borrow a few hundred million to invest in a value like that, I might take it too.
No harm, no foul
Don't get me wrong: I respect Jim's views as an analyst and writer. In my humble opinion, though, Netflix deserves some credit for making a gutsy call. I'm just here to give the other point of view. Time will tell who ends up being right.
Whether I just opened your eyes to a whole new world or you still agree with Jim's critique of Netflix, you can discuss the finer points in the comments below.