More on Netflix

Well, the last three months certainly have been eventful for Netflix.  As of now, the stock is only worth about a quarter of what it fetched back in July.  The latest nail was struck after the quarterly report when the company warned that it might be unprofitable in 2012 due to the costs of international expansion.  Reed Hastings went from the being the smartest CEO to apparently the dumbest.  A number of articles appeared in financial press claiming that Netflix streaming model is unsustainable and predicting company bankruptcy (!) within a year.

Without a doubt, PR around recent price hike and the whole Qwikster debacle could have been handled better.  But what has really changed?  The 800,000 subscribers lost during the last quarter is a big number — but Netflix still has 24 million subscribers who apparently value the service even after the price increase.  Starz decided not to renew its streaming deal, but Netflix signed up a number of other studios instead.  Finally, Netflix could show good profits next year, but instead it chose to use the funds to invest in growing the business by international expansion.  Does all of this really deserve 75% haircut?

Well, of course it is debatable whether $300 price tag was justified in the first place.  Looking back at stock price history, a very similar drop happened before, back in 2004.  Then, Netflix had to lower prices to fend off Blockbuster’s Total Access program, and the stock promptly tanked from over $40 to just below $10 — a 75% drop.  For 5 years after that, the stock price was stuck in a trading range between 15 and 30, and it took off with a vengeance in 2009.

I believe that we could be in for a similar trading range for the next several years.  Currently, the stock is cheap based on fundamentals, such as price-to-sales ratio.  Also, any number of cash-rich companies, for example, Amazon, Apple, Microsoft, Google, etc. could acquire the company with minimal impact on their cash position.  This should provide support for the stock.  On the other hand, I don’t see any catalysts to propel the stock forward in the near future.  The prospect of unprofitable 2012 will certainly make short-term oriented Wall Street analysts to talk down the stock and this will put a lid on meaningful appreciation.

Can Netflix reach $300 again?  I think it is very possible, if the company can still attract U.S. subscribers and if it is successful in its international expansion.  I think that current price levels present an excellent opportunity to long-term oriented and patient investors.

Worst Quarter since 2009

As the title implies, the market performance this quarter was the poorest in nearly three years. Only Q4 of 2008 fared worse, and as you recall stocks hit a bottom soon thereafter in March 2009, and went on for a two year climb. There are several similarities between the situation now and back in 2008. Then, the markets were focused on the fallout from the banking crisis here in U.S. Now, it is a macro issue again, this time sovereign debt situation in Europe. On the valuation basis, stocks are now at the level of late 2008 – early 2009. An important difference is that balance sheets and company earnings are in incomparably better shape now than three years ago.

However, the markets don’t seem to pay attention to individual company performance lately. Even recent fairly positive economic reports from the U.S. – such as a solid manufacturing report, upward revision of GDP, and lower unemployment claims – have been ignored. Instead, the markets choose to focus on the possibility of Greek default. The situation in Europe is indeed uncertain and without a doubt can cause further market turmoil. In fact, most observes believe that Greece default in some form can not be avoided. Many economists also think that U.S. will enter (or already have entered) another recession and that it will have a negative effect on the currently stellar company earnings. In appears, therefore, that the market is already pricing in these outcomes.

Right now, the markets trade on fear and on uncertainty. As we gain more clarity into the macro issues, company fundamentals will once again drive company valuations. The coming earnings season will provide some insight going forward. I believe that combination of current extreme pessimism and 2008-like low valuations present an excellent buying opportunity for equity investors.