Sometimes you look at a stock like Netflix when it was trading at $300+ and think “Here is a great company in a market with super growth, but how can I justify the price?”

Well, it turns out you don’t have to justify the price because the market is beating the shit out of the stock. It’s trading after hours right now at around $86, and who knows where the market will take it.

Hip Egg had the next level of support at around $60, so I would look for the price to gravitate towards that level.

I own a small number of shares bought in the $113-$130 range. I thought that Netflix might blow away earnings due to the price increase (and they did), but the sandbagged forecast they gave is scaring more investors away. I plan on double or tripling my position as the price falls.

With the stock under so much duress why am I a buyer?

Because Netflix is still the best video streaming company by a long shot and the growth prospects there are extraordinary. This company is going to make a ton of money. They may not get the price bonus they got as a WallStreet darling, but pretty soon the earnings will force people back into the stock.

I think the company is on a good path right now. I had my doubts, especially when they announced that Qwikster business. I thought they were panicking and losing site of the strengths of their platform. Hastings, who was probably too aware of customer complaints about seeing titles that were only available on DVD, seemed surprised that users would want to see both streaming and DVD titles in one queue.

It was a welcome site to see them reverse that decision. And Hastings’ explanation that the DVD business “holds value for our 10 million subscribers” is great and shows that they are really thinking about what is best for their customers again.

I think most people by now agree that the price change (really a price alignment) from earlier in the summer was the right move. It makes sense for people who want DVDs to pay for that package separate, and for people who want streaming to pay for that package separate. And I don’t blame the Netflix executive team for not anticipating the backlash that occurred. To me the story was always like this:

You know those streaming movies that you’ve been getting for free with your DVD package for the past year? Well, now you’re streaming more movies than you are getting on DVD. We’ve come up with a price for the streaming service. It’s only $7.99. That’s less than you were paying for your DVD plan before, and hell that’s only $7.99 now too. That’s less than any other competitor, and we still have the best service.

Risks to the Business

For me, the biggest risk to Netflix’s future profits was in their ability to obtain more material for their streaming service without being shook down. The studios owning video content have a lot of motivation to play hard ball with Netflix on their prices. Conspiracy theorist will see them working together cartel-style to see a company they are more friendly with oust Netflix as the market leader. Maybe Hulu because they own a piece of it… or Amazon or Walmart because those companies sell so many DVDs and BlueRay Discs for them already. But even without illegal price-fixing, it’s easy to see the studios going after Netflix because the money is there, and other sources of money may be drying up.

I’m still worried about the content problems, but I think Netflix has a handle on it. They are throwing money at it, which is good. This will increase their library and their costs, but their other costs are going down. Streaming is cheaper than mail. And user acquisition costs are down as well.

I think there is a new risk to the stock and the business though. And that is the risk that the board will give into public pressure to relieve Reed Hastings. I don’t want to start rumors or drum anything up. But there are a lot of jaded investor folks who are asking for Hastings’ head. I don’t know if the board is behind their man or not. I’d like to research that some more to see where the board stands.

A drastic seat change like that would obviously be yet another blow to the stock price, and I’m not sure the replacement would have the vision Hastings has for the future of streaming at Netflix.

Risks to the Stock Price

The price will drop tomorrow. It probably will go down further. Management is warning that Q4 revenue and earnings may come in lower. Even more, they are saying that earnings in Q1 will be negative as they spend more money on expansion and licensing deals.

Support is in the $60 range, but who knows if that will hold. Amateur investors will bail more as the stock price falls. Institutional investors will bail more as earnings go into the red.

The Bright Side

Netflix will continue to grow subscribers world-wide and will continue to make money. Netflix typically has strong fourth quarters. (Anecdotally, I know a lot of people gift Netflix for the holidays. And a lot of people pick it up to take advantage of new TVs and gadgets.)

If the price really drops to $86 or so. With earnings around $4 a share, that’s a PE of about 22 for a company that is growing at 50% year of year.

Netflix currently has about 24M subscriptions. There is plenty of room to grow. There are at least 96 million cable/etc subscriptions in the US. Imagine 96M Netflix subscribers.

Throw in growth overseas.

Tomorrow, the single largest source of internet traffic in the United States will be run by a company with just a $4B market cap. Netflix owns a huge portion of our mindshare that will only grow larger. As long as they stay smart and continue to perform to their own standards, their business will flourish. Investors will have to return.

Comments (2)

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I give you the credit for not letting emotion get the better of you in choosing to invest in Netflix stock. After just about any stock taking a beating like that most people are extremely afraid and with good reason. I understand the growth and leadership in the sector but question the management especially with that NetEase failure. Perhaps the prices were justified but they were ill-timed and could have been better addressed to the users. Yet, as you note they still have plenty of subscribers and this is where the profits are.

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Thanks for interesting blog post. You guys are always provide information that it makes it impossible not to want to buy your next product ;I can

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