Event: Netflix (NFLX) will report Q2 results tonight after the close. The options market is implying about a 10% one day post earnings move, which is basically in line with the 4 quarter one day average move, yet shy of its 10 year average of about 13%.
Price Action / Technicals: NFLX is down about 14% on the year, and down about 16% from its all time highs made in early December. The year to date declines are equal to the stock’s one day decline following their Q1 results in mid April.
Since the December highs, the stock has been in a well defined downtrend, having made a series of lower highs, but since its February lows at $80 (which marked a 40% peak to trough draw-down) the stock has seemingly stabilized, having just this past week made a series of closes above the downtrend line:[caption id="attachment_65076" align="aligncenter" width="600"] From Bloomberg[/caption]
To drive home the importance of the technical relevance of the current technical set up for NFLX, a failure at the downtrend, and a post earnings decline equal to the implied move would have the stock back towards having an 8 handle. $80 is massive long term support:[caption id="attachment_65077" align="aligncenter" width="600"] From Bloomberg[/caption]
What to expect? Let’s first go back to mid April and get a sense for what caused the post earnings downdraft, per Bloomberg:
Netflix signed up 4.51 million customers internationally after expanding to 130 new markets. That brought the worldwide total to 81.5 million. The company had projected 1.75 million new U.S. customers and 4.35 million overseas.
First-quarter net income rose to $27.7 million, or 6 cents a share, from $23.7 million, or 5 cents, a year earlier. Analysts were forecasting 4 cents, the average of estimates compiled by Bloomberg. Sales grew 24 percent to $1.96 billion, compared with projections of $1.97 billion.
But it was decelerating North American growth, coupled with a very disappointing outlook for international subscribers that spooked investors, as more than 60% of their 81.5 million subs are outside North America, and much of their expected growth. The company’s reliance on original programming to drive new subscribers caused a fairly precarious free cash flow situation for the company. Per Suntrust Robinson Humphrey analyst Bob Peck back on April 19th, post Q1 results:
Other Key Items: Out-Year FCF Guidance Slightly Below Consensus. 1) Management expects FCF: in 2016 to be negative ~$1b (unchanged), in 2017 to be negative ~$1b (consensus -$0.5b), in 2018 to be negative (consensus +$0.1b). We believe out-year consensus profit and cash flow estimates may need to come down, as previewed. 2) Relatedly, the company expects content spend on the P&L (amortization) to be >$6b in 2017, from <$5b in 2016, with cash spend again greater than P&L amortization spend. 3) Management continues to expect to raise high yield debt in late 2016/early 2017. 4) Consolidated revenue/EPS was $1.96b/$0.06 vs consensus $1.97b/$0.04, with below the line items ($24m FX gain) added net ~$0.03 to EPS
IN the quarter there were some fairly significant announcements that might offset one another from a sentiment standpoint in the near term. First, back on their Q1 call they announced a price increase for long time customers (of which I’m one and will see my $7.99 monthly subscription go to $9.99 late this month). And second the announcement earlier in the month that Comcast will allow streaming of NFLX On their X1 set-top box platform. This sort of distribution on the platform of a prior nemesis should more than offset near term churn from the price increase and possibly help re-accelerate domestic subscriber growth. There are of course a whole host of competitive challenges emerging from massive tech and media players, from Amazon, Apple, Hulu, Time Warner/HBO etc etc etc, so the moat that NFLX thinks they have for streaming video might end up being less impenetrable than uber NFLX bulls think in what is an increasingly fluid digital streaming landscape.
My View: NFLX may finally be approaching that existential moment of relevancy. Investors might consider whether they are going the way of Tivo or fulfill the promise of supplanting long established monopolies in content distribution. I’ll save that discussion for another post.
I suspect of most focus will be international subscribers for the second straight quarter. The guidance was so poor (2.3 million vs 3.45 million consensus) that a miss of that would be an all out disaster, even if they expected a pick up in the back half of the year, investors will not believe them. In that scenario the stock is in the $80s, likely on its way to the long term support, as there is little valuation support.
On the flip-side, a beat of that guidance, a guide up of 2h international sub growth and stable domestic, and the stock is at $110 very quickly.
Of course, the stock has spent most of 2016 finding sellers above 100 and buyers on moves below 100. And there’s potential to for that trend to remain no matter which direction the stock goes on earnings.
We are looking at possible trade set ups, stay tuned.