3nd Update: Netflix (NFLX): Q3 Earnings Preview and New Short-Term Bearish Trade

by Dan October 26, 2011 3:41 pm • Commentary

3rd Update Oct 26th, 2011 at 3;42pm: With the stock back at 80, I am going to sell half of my existing position at 4.75 (originally paid 2.30).  Now I leave a qtr of my original position and will try to realize a bit more of the width of the spread.  Remember I only have 2 more trading days until weekly expiration.

2nd Update Oct 25th, 2011 at 2:05pm:  With the stock at 77.75 I sold half of my position at 4.60, double what I paid and taking my cost off the table….I will now let the other half ride and see if I can realize a greater amount of the spread of the fly.

Update Oct 25th, 2011 at 9:30am:  As many of you know by now, NFLX is down about 37% in the pre-market, below the 75 strike put I am long as the lowest leg of the Put Fly (below) that I am long….this is the worst possible scenario……I go the direction, and the reason for the direction correct, but the magnitude of the move wrong……

So what to do now?  I guess there are only 2 things you can do…1st wait to see if the stock rallies back a bit, or 2nd try to salvage as much  premium as you can soon after the opening….

The way I see it, you might as well wait a bit as a 37% move after the stock has been down so much is getting a bit overdone…..I think there is a good chance the stock rallies back a bit before Friday…..

Check back for more updates on this trade as I will be watching it very closely…..also be sure to sign up for the appropriate updates and update delivery on the main page…..


Update Oct 24th 2011:  Netflix (NFLX): Q3 Earnings Preview and New Short-Term Bearish Trade

Event: NFLX reports Q3 earnings tonight after the close…….the options market is implying about a 13-15% move following earnings depending how u look at it…… the average move over the past 8 qtrs has been about 13%, which doesn’t include the the Sept 15th pre-announcement that saw the stock crater 18%.  The stock can clearly move, but I guess the million dollar question is what is in the stock at current levels, down 50% in 2 months??

The Street remains fairly mixed on the name with 11 Buys, 16 Holds and 5 Sells, and my sense from reading through a bunch of analyst previews that the many are waiting for tonight’s call to make a decision on their current estimates and or rating.

From GS Preview Oct 2oth, 2011: 

We believe that the key to the stock working will be whether management can show a path to growing subs again, as the only way the streaming business model works is if Netflix can continue to grow domestic subs to achieve greater scale and margins given its fixed content costs. We believe that Netflix should do the following: (1) Acquire more streaming content rights – while we believe that Netflix has acquired the majority of attractive content that is available (ex-Starz), we found it encouraging that Netflix was able to acquire DWA’s streaming rights one year earlier than expected; (2) Increase marketing spend – while we believe this is a short term solution, we believe that Netflix could do a better job marketing the streaming content it already has; and (3) Introduce new services, such as transactional VOD, creating a “new hybrid” service.

From Citi Preview Oct 20th, 2011:

Our NFLX Valuation Approach

We believe it’s key to note that NFLX has two businesses – one its U.S. segment and other its International segment – that are at very different life stages. NFLX’s U.S segment is hitting record high Operating Margins, while NFLX’s International segment will likely be deep in investment mode for several years. This, requires, we believe an Some of the parts…..

We are valuing NFLX’s U.S. segment at approximately $200, applying a 25X multiple to our 2012 U.S. Non-GAAP EPS estimate of $7.87 per share, which is based on $3,922MM in revenue and a 16% Operating margin. We use a target P/E multiple of 25X, given the company’s robust domestic core metrics growth as well inherent operating leverage due to a subscription-based business model. For key context, we are modeling 30%+ U.S. Operating Income growth in both 2012 and 2013.

Since we are projecting NFLX’s International segment to remain in loss/investment mode through at least 2013, we have applied a “mature” Operating margin of 20% to our 2012 International revenue estimate of $265MM to generate $53MM in Operating Income. Using an International tax rate of 30% and applying a 25X multiple to that estimate generates an additional $17 per share in value. The sum of these two segments is $220 (rounded), after we adjust for approximately $5.00 per share in cash.

MY TAKE: Short interest remains very high even with the stock down almost 62% since making all time highs in July.  On Bloomberg’s last short interest reading it remains at about 15% of the float, down about 3%.  I mention this because any decent news that is unexpected could have the stock up sharply, as shorts may feel that the stock has finally bottomed…..

I will honestly tell you though that as long as I have been doing this, I have never seen a momentum name like this break, by their own doing, not market related and ever come back to its once cult status….now that doesn’t matter much for those of you who are looking to play earnings but I think for investors hoping for this thing to get back to $300, you may not want to hold your breath.

Last month in the post below, I referenced a Merrill Lynch research note and some press reports that AMZN should look to acquire NFLX, and then I agreed that they should do it, but I have obviously have no clue whether they will or not.  On that front, I am not sure that NFLX founder Read Hastings would go out that way, he seems like the sort of guy who has no problem eating crow every so often and likely feels a certain obligation to right the ship……

I think the only way to play this is having some conviction and picking a direction, to buy or sell the implied move, you have to be a bit savvier than me…..

Techncially the chart looks like it could go either way in a big way, and given investor anticipation, I think it likely will.

NFLX 5 month chart from Bloomberg


So it all comes down to guidance for Q4 and at this point I have to think given the waves of defections that they have seen since the July Price hike, and then to the Sept/mid Oct Quickster disaster that visibility will be hard to come by…..

The hard trade here is too press the short and play for one last puke to the downside…..I think the only way to do that is by defining your risk in a low premium fashion.  

I guess the issue here is that if investors sense that the company has no real strategy to win back streaming subs without huge marketing spends and costs associated with acquiring content than then they may hate the sell the stock below $100.

As many of you know I prefer to take contrarian views, and as evidenced by the trade below< i put one on in this name last month when the stock was about ~10 higher looking for a take out by Jan Expiration.

I want to make one last play on the short side for I feel has the potential to be the final puke in the name….

TRADE: NFLX (116) Bought Oct28 weekly 105/90/75 Put Butterfly for 2.30

-Bought 1 Oct 105 put for 3.95

-Sold 2 Oct 90 Puts for a total of   1.82 ( .91 each)

-Bought 1 Oct 75 Put for .17

Break-Even On Oct28th weekly Expiration:

Profits btwn 102.70 and 90 make up to 102.70, at 90 make full 12.70 and btwn 90 and 77.30 pay off trails off.

Losses btwn 102.70 and 105 lose up to 2.30, above 105 lose all 2.30, btwn 77.30 and 75 lose up to 2.30 and below 75 lose all 2.30.

TRADE RATIOANLE: As I stated above I think there is a lot of bad news in the stock and with short interest still very high I think you want to be careful how you play this from the short side………Near term if the company tells us that visibility is fine I wont believe them….so I want to find the lowest premium way to get the stock below 100 in line with the implied move….If the company is honest, in my opinion, Q4 subscriber guidance should stink and visibility into next yr should be horrible, if the company does not answer the hard questions on the earnings call, investors will head for the hills…..

* As always in multi-legs flys, use limits…..



Previous Post Sept 26th 2011: Netflix (NFLX): If You Can’t Beat ’em, Join ’em…Some Think AMZN Should be Lurking

NFLX has been one of those stocks that unless you had balls of steel and grown them in the last 2 months, it has almost been impossible to make money on the short side….I have tried desperately to short this name, through Put Spreads, Put Flys and Put Trees, I am hard pressed to think that I have broken-even over the last year or so paying lots of bid/ask and expensive premium.

The stocks recent sell-off, since making all time highs at ~$304 in July, is eye popping at about 57%.

Bank of America Merrill Lynch in a note to clients this morning spoke about NFLX’s attractiveness as a takeout candidate:  

Buy-out becoming more likely
We have written on the media’s on-going speculation about potential Netflix
acquirers before and had concluded earlier that the most likely buyers who have
the financial wherewithal to buy Netflix, namely the large Internet and tech
players, would not be interested in Netflix’s physical distribution business. Now,that has changed with Netflix effectively spinning their DVD business off into a
completely separate operating entity that could be spun off or sold to private
equity by a potential acquirer.
Amazon, the most likely acquirer
The most often cited buyer, and in our view the most likely, is Amazon.  Articles
such as “Amazon may again be mulling Netflix buy” from the WSJ and “Amazon
Buys Netflix? Microsoft Is a Much Better Guess as a Potential Acquirer” from
AllThingsDigital have suggested Amazon could purchase Netflix.  We believe
Amazon likely couldn’t buy Netflix in the past because Netflix’s DVD distribution
centers in virtually every state would have given Amazon “nexus” in those states
for sales tax purposes, forcing them to collect sales taxes on every item sold in
the US.  Now, Amazon who has already shown a commitment to building a
streaming service, faces the choice of spending hundreds of millions to more than
a billion a year building out a content library to compete with Netflix and thus
significantly diluting earnings for the near term, or of buying Netflix with stock
and jumpstarting their efforts with what should be a very accretive transaction even at
much higher levels.

I have fielded many questions from readers on this topic and frankly haven’t had a strong view on the matter…..Merrill’s note doesn’t particularly have a strong view but just making the subtle case why it could be a good deal for AMZN. While a deal in the $10bil range is doable for AMZN, probably a combination of cash and stock….the largest deals they have done in e-commerce was the 2009 acquisition of Zappos for $1.2bil. Now that NFLX intends to split up Streaming vs DVD, maybe as stated above AMZN would get more aggressive to move on the Streaming portion to avoid the tax collection issues.

MY TAKE: This all makes a lot of sense, especially when you consider AMZN’s business momentum in so many categories and that a deal of this size would make them a serious player in streaming content and make them a formidable competitor to iTunes. If I were Jeff Bezo’s I would try to get this deal done for the streaming portion, especially as they are looking to compete with AAPL in the tablet space more and more outside of bookreaders…..

If you want to play for a take out I would be careful selling puts to finance the purchase of calls….the company has made a series of bonehead moves in the last 2 months and they have given no indication that they are done with that strategy. Even-though implied volatility is through the roof, I think the only way to play is long premium with eye towards defining your risk.


NFLX ($127) Buy Jan12 175/200/225 Call ButterFly for 1.50

-buy 1 Jan12 175 Call for 8.00

-Sell 2 Jan12 200 Call for a total of 9.00 (4.50 each)

-Buy 1 Jan12 225 Call for 2.50

Break-Even on Jan12 Expiration:

Profits: btwn 176.50 and 200 make up to 23.50, at 200 make 23.50, payout trails off btwn 200 and 223.50…..

Loses: btwn 175 and 176.50 lose up to 1.50, btwn 223.50 and 225 lose up to 1.50, below 175 lose all 1.50 and above 225 lose all 1.50

** As always in multi leg orders use limits, there is a ton of bid/ask and the spreads are wide…..

TRADE RATIONALE: this is a low probability play, the Jan12 175 call that you would be long has about a 30 delta, basically the options market is telling you that there is only a 30% chance that the call will be in the money on Jan12 expiration. But if you think there is a greater probability that AMZN takes advantage of NFLX’s recent misfortune than time is not likely on their side and they should probably move and soon…..So you have to get a lot of things right, timing, price and a deal for this to make money…..but you are risking less than 1% of the underlying and if you get it right you could easily make 10x your money with a deal close to $9-10billion which gets you back to $200.


This is not a fundamental call on their existing business, this is about the replacement value of the asset to a potential acquirer, this current quarter is likely to be very bad given all of the customer defections.


Stock broke down at $200 and now that seems to be a fairly interesting resistance level. $200 seems like a very healthy premium to current levels and technically deal or no deal a level that the stock would likely pause at on any sustained rally.

[caption id="attachment_4984" align="aligncenter" width="300" caption="1 YR NFLX chart from Bloomberg"][/caption]