UPDATED with closing price: Divergent opinions about Netflix’s prospects continue to ricochet around Wall Street in the wake of the company’s second-quarter earnings miss, but investors today could sum up their feelings in a single word: sell.
The company’s shares, which had surged nearly 110% in 2018, imputing a higher valuation for Netflix than those of Comcast or Disney, fell sharply from the moment the opening bell rang. While at one point the drop was in the double digits, they recovered a bit to finish down 5% at $379.48, compared with Monday’s closing price of $400.48.
In the second quarter, Netflix said it added 5.2 million net new subscribers, which is 1 million shy of the company’s internal estimates and the expectations of many Wall Street analysts. It was the first such miss since the first quarter of 2017. In executives’ quarterly video conference addressing the numbers, they shrugged that the shortfall was simply due to a forecasting pendulum swing. Prior quarters saw them blowing past their own estimates, so they said they adjusted their targets accordingly. CEO Reed Hastings insisted that the company’s “fundamentals have never been stronger,” citing healthy metrics like overall viewing and 12-month rolling subscriber levels.
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Despite all of the sanguine commentary, the quarterly showing rekindled an ongoing debate about the company’s trajectory, investment thesis and rightful place in the media ecosystem. For some wary investors, the company is an unprofitable risk not worth taking. Its unprecedented levels of spending on programming are simply not sustainable, according to this pessimistic view.
Bulls counter that Netflix has built a better mousetrap. By continuing to build a massive well of original content that travels to (and increasingly originates in) nearly 200 territories around the world, it has the ultimate technology-enabled moat and will continue to grow.
This existential debate is playing out in a series of analyst reports that keep landing like horseshoes in a sand pit.
Eric Sheridan of UBS, who downgraded the stock to neutral from buy last week, called the quarterly results a milestone. “We see Netflix’s Q2 results and Q3 forward commentary as a clear break from recent business model momentum,” he wrote. Even so, “longer-term, we still see Netflix as a global leader in streaming media and that Netflix management’s focus on expanding the competitive
moat via a mix of content spend, brand/content awareness (through marketing spend) and subscriber growth all continue to point to sustained topline growth & forward margin
As investors “digest” the decline in the share price, he added, “we would not be surprised if the stock remains range-bound.” Valuation, free cash flow generation and the potential impact from rival services like Disney’s forthcoming one, will all weigh heavily on investors’ minds, Sheridan said.
Mark Mahaney of RBC Capital Markets maintains an “outperform” rating on Netflix and made an upbeat case despite the “very weak” quarterly numbers. “We’ve seen this movie before,” he wrote. “After four quarters of beating internal expectations, Netflix missed them this quarter. We note that Q2 is generally one of the lumpiest (i.e. weakest) quarters for the company as summer rolls around and sub adds decrease, adding difficulty to the forecast. We think World Cup distraction may have hurt Q2 slightly as well, as did lack of a mega-release like 13 Reasons Why.” Even so, “long-term fundamental trends remain intact.”
Todd Juenger of Sanford Bernstein, who moderated the quarterly executive video conference yesterday, raised his 12-month target price to $434 from $372. The increase was partly due to methodology, but Juenger also conceded being part of a group he called “high-conviction bulls on a long-term thesis.”
Guggenheim’s Michael Morris titled his research note “Superhero or Mere Mortal?” He lowered his 2018 and 2019 earnings forecasts, but held steady with his $360 12-month price target. BTIG’s Rich Greenfield, a noted critic of many purveyors of traditional TV bundles, went the other way. He upped his price target to $420 from $330 and also increased his 2019 and 2020 financial estimates because Netflix is merely “at the starting gate” in Asia.
Michael Nathanson of MoffettNathanson came clean about the “terrible call” he has made in not recommending the stock. But even though he described the second quarter as “anomalistic,” his report spells out deep reservations about Netflix’s long-term prospects.
“The barrier to entry here, in part, is sourced by spending more money faster than others can,” Nathanson wrote. “There is little sign that rivals are falling away. In fact, as Netflix noted, other larger, better funded entities are entering this space.”
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