June 22, 2016

Netflix is looking like AOL from the 90s

I continue to regard Netflix as unattractive, and I remain short on the stock.

While the FANGs have propelled the market's growth segment higher, I think the fundamentals justify the "F," "A" and "G" components' gains (although valuations are another story).

But in my opinion, that's not the case with Netflix. Its only attraction in my view is the yet-unproven notion that the company has pricing flexibility. If it doesn't, then the stock will eventually hit troubled waters, given that it has:

-    A valuation of more than 100x 12-month-trailing EBITD.

-    Relatively unexciting sales growth (currently about +24%).

-    Little likelihood of margin expansion given Netflix's rising content costs.

AOL Redux?
Just as AOL did in the late 1990's and early 2000's, NFLX shares dance to the tune of subscriber count. And each quarter, the company consistently exceeds forecasts for that (which are probably managed). But also like AOL, Netflix has little free cash flow -- and to me, the stock appears to be enjoying its last hurrah.

Unlike fellow FANG components Facebook, Amazon and Alphabet/Google, NFLX is down some 30% from its highs. And its chart (lower highs, etc.) should terrify anyone who practices the dark art of charting.

Netflix has tried to energize its supporters with foreign growth, and has added new nations to its operating area at a sizzling pace. The company now services over 130 million customers, many of them recently added.

So, subscriptions will surely exceed forecasts ... but revenues and the cash flow might not follow.

Other potential problems that have recently surfaced:

-    Non-U.S. subscribers might want local content. This will escalate content-procurement costs (possibly geometrically). Even worse, foreign governments might require local content as a condition of Netflix operating within a given country.

-    While an $8 to $10 monthly subscription price is reasonable in America, it might not be in other countries. For example, India might be a less open-ended market for Netflix than NFLX bulls suspect.

-    In my view, the company needs capital that might not be so easy to obtain despite Friday's near-zero cost for it. I was surprised that Netflix didn't sell equity or convertible preferred shares when its stock was trading at around $130 a share (vs. some $94 Friday).

The bottom line: It should be interesting to see how this situation unfolds. But at best, I think it should be observed from the sidelines!


Position: Short NFLX

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