Forget Netflix's stock volatility, the real news is its long-term plan is taking shape
Another quarter, another huge gap in Netflix's stock price as investors sift through the messy tea leaves that is its quarterly letter to shareholders.
After rising 3 percent during trading hours Tuesday, Netflix's stock rose another 16 percent in after-hours trading following the company's earnings report for the last three months of 2014. That rally brought Netflix's stock as high as $404 a share, its highest level since, well, since its last earnings report.
Only three months ago, Netflix shares lost 25 percent of their value in one day after investors freaked out about its financial metrics. The key issue then was tepid US subscriber growth, which not only declined year-over-year but was below what many analysts were forecasting.
This time, subscriber growth in the United States was still below what it was one year ago, but it was above analyst expectations. Netflix said it added 1.9 million domestic subscribers for its streaming video service last quarter, slightly ahead of the consensus forecast of 1.85 million additions. Believe it or not, that very modest surprise appears to have been enough to add $3.3 billion to Netflix's market value.
But this is nothing new for Netflix. And judging from comments from CEO Reed Hastings, it's the kind of thing that can drive a CEO crazy. Every quarter, Netflix gives plenty of different metrics on its business operations – some encouraging, some discouraging — but the ones that drive the stock movement in the short term can be pretty random.
For example, today's report also brought evidence that Netflix bears took as worrisome signs. Netflix is forecasting a net profit this quarter of 60 cents a share, well below the 77 cents that Wall Street had been forecasting. What's more, free cash flow – a measure of how much money the core business is generating – fell to negative $78 million, its worst free-cash-flow figure in years.
And yet investors zeroed in on the net-subscription-growth figure. But even here there was some worrying news. In October, Netflix explained the slowdown in subscriber growth as a function of an increase in its monthly fee for new subscriptions. On further examination, Netflix now believes the real reason is longer-term - and more disconcerting. As the company said in its letter to shareholders,
With additional research, we now think that the decline in y/y net adds would have largely taken place independent of the price change… We think, instead, the reduction in y/y net additions is a natural progression in our large US market as we grow.In other words, now that Netflix is in a third of US homes, it's already showing signs of market saturation blunting its potential for future growth. There are two reasons why investors would shrug off this bad news: because they're too busy covering short positions, or because they are actually beginning to buy into the long-term case for Netflix that Hastings has been making for years.
As if telling a child for the hundredth time that vegetables are good for him, Hastings spelled out, sometimes in bold text, the Netflix game plan: "It is increasingly clear that virtually all entertainment video will be Internet video in the future. We’ll continue to improve our content, our marketing and our service, to eventually achieve 'must have' status in most households."
Hastings and CFO David Wells also explained that Netflix original content, like House of Cards and the critic-drubbed Marco Polo, cost less money than licensed content, and that Netflix will continue to spend cash over the next couple of years on new original content, even if it means taking out more debt to do so. (Also, critics may have hated Marco Polo but many viewers in various countries loved it enough that Netflix is supporting a second season.)
The slowdown in US subscriber growth may well be offset by Netflix ambitions in overseas markets. The company added a net 2.43 million subscribers in Canada, Latin America and Western Europe. This quarter it will be launching in Australia and New Zealand, with plans to enter other high GDP-per-capita markets soon after. On a conference call, Hastings said Japan and South Korea are possibilities, while the company's move into China will be cautious.
Overall, Netflix now offers its premium subscriptions in about 50 countries and plans to accelerate that quickly to 200 countries. Unlike Amazon's Bezos, Hastings is willing to offer a specific deadline: Netflix will complete its global expansion in two years and "generate material global profits from 2017 onwards."
Netflix core vision hasn't changed much in a decade – be the first to offer high-quality streaming video to as many people as possible, with the goal of being, if not the industry leader, then one of the few must-have video providers. What is new is the company putting a clear goal on turning that vision into steady global profitability.
That clarity may not keep Netflix stock from the volatile swings that seem to afflict it with every earnings report, but it should come as encouraging news to investors who have held onto the stock during all its turbulent rides.