Netflix Inc. (NASDAQ: NFLX) was up over fifty bucks in after-hours trading after it reported first-quarter earnings following Wednesday’s closing bell. This came even as the company reported a decline in net income and free cash flow.
DVDs are on their way out, so it is no surprise that Netflix’s streaming division is where the company is making money. Consolidated streaming revenue was up 34% to $1.4 billion. Segment contribution profit was $247 million, up 50% from $166 million. Segment margins improved 190 basis points to 17.7%. Netflix added 4.88 million members to total streaming.
This is consolidated, however. The company continues to lose money on its international streaming. The segment has 19 million international streaming members, and 2.6 million in new additions. But the segment’s loss widened to $65 million from $35 million. In the second quarter it is expected to lose $101 million, following last year’s $15 million loss.
DVD members fell from 6.5 million to 5.5 million, as revenues fell from $204 million to $173 million and contribution profit dropped to $84.6 million from $92.7 million.
On a consolidated basis for the whole company, total revenues increased from $1.27 billion to $1.57 billion, or about 25%. The cost of revenues increased from $869 million to $1.05 billion. Marketing costs increased from $137 million to $194 million.
The net result was that net income dropped from $53.1 million to $23.7 million. Free cash flow was negative $163 million.
Meanwhile, bond investors have no problem throwing money at Netflix. The company issued $1.5 billion in debt, at a weighted average of 5.7%, split between 7- and 10-year notes. That brought Netflix’s cash position to $3 billion.
On a valuation basis, trailing 12-month net income is $223 million, and Netflix’s stock market cap is now $32 billion, giving the stock a trailing P/E ratio of 150.
Let me repeat that: A P/E ratio of 150, on a company whose net profit fell year-over-year.
I don’t get it. However, let’s try and figure out what the market thinks and why it sends Netflix stock higher on lousy news.
First, assume the DVD business is gone in three years. U.S. streaming is indeed a tidy little business. International streaming is a money pit. Yet at half the subscriber numbers of domestic, it should be doing better.
Of course, with all the cash it now has, it’s obvious Netflix is moving to become an even more active player in original programming. That’s great, of course, because the programming is excellent. However, the return on investment is impossible to determine, because Netflix never tells us how many people actually watch their programs.
With the rise of on-demand streaming, Netflix is obviously well-positioned to become an a la carte “channel” providing both licensed content and original programming. All of that costs money.
The original programming side requires hard money to produce the programming. The licensed programming will always be there, and the off-balance sheet liabilities are more virtual than real, because if Netflix doesn’t have the money to pay for whatever was originally negotiated, they’ll just re-negotiate with the content providers.
You see, content providers are the studios. With the exception of rare exclusive license deals, the studios will license their content to anyone willing to pay for it.
If Netflix can’t live up to an agreement because money is tight one quarter, then they’ll take less and make it up later. Or not. It doesn’t matter. To the studios, which are the vampires, Netflix is nothing more than a perpetual source of blood hooked up to the sucking machine.
Netflix stock will not be cash flow positive for any sustainable period in the next five years, if not longer. The studios will always suck it dry.
At some point, the company will also raise prices. As DVDs go away, that revenue has to be replaced. First, U.S. subscribers will see increases. Once a larger international foothold has been set up, the foreign viewers will get price increases as well.
I suspect that Netflix is simply biding its time for when streaming is internationally ubiquitous and most content is on-demand. Only when the international subscriber base is something like 125 million, with everyone paying increased fees, does the company truly become an ongoing profitable and cash-flowing enterprise.
In essence, then, I believe investors are pricing Netflix earnings for the year 2022.
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