Netflix (NFLX) - Get Report shares are down almost 20% since the company reported disappointing Q2 results on July 17. Nothing has changed for Netflix, however, which means it may be time to step back into the stock.
The key to Netflix is that the market avoids what's certain about the company and its market, and focuses instead on what's uncertain. But it's the certainty that endures and that's what argues for a buy of the stock after the recent drop.
What is certain about Netflix is that it has a finite opportunity, its growth is slowing and it is loaded with debt it may never earn back. What is also certain, however, is that Netflix continues to find ways to suck up time among millennials and Gen Z consumers, a kind of automatic go-to to fill the empty hours of their lives.
And just as certain is that as long as interest rates are low -- and they got even lower last month, with the Federal Reserve cutting its benchmark Federal Funds rate for the first time in a decade -- borrowing money to fuel that video addiction by young viewers makes sense because it's nearly-free money for Netflix.
What is uncertain about Netflix and what investors focus on are the ups and downs of its paid subscriber additions. On July 17, the company announced that it missed its own target for 5 million paid net additions to its streaming platform, reporting instead only 2.7 million additions to the platform, a huge miss.
It's natural to focus on what's unknown, since it provides a greater opportunity for information arbitrage in the stock market, which is attractive with a momentum stock. And Netflix's management, intentionally or not, stokes the uncertainty by sounding witless every quarter about how they forecast their subscriber numbers.
Netflix's earnings report on July 17 was a classic example. The company's shareholder letter from founder and CEO Reed Hastings offered a scatter plot showing how many times the company has gotten its forecast wrong. It was as if to say "we have no idea how our business grows."
On the conference call, managed as usual by a single analyst with no chance for outside voices to ask questions, Hastings and his staff -- content lead Ted Sarandos, CFO Spencer Neumann, and product lead Greg Peters -- could shed no light on why they missed so badly with their forecast. Netflix management apparently can't forecast in any time period, and they don't even appear able to articulate what kind of logic goes into those failed forecasts.
Hence, Netflix stock constantly moves on surprises about subscriber numbers, either good, or, as in the July report, bad. This time, the miss in July was so big that some analysts wondered if something serious had changed. Long-time bulls appear shaken by the subscriber miss, as a big part of the reason may be that Netflix raised prices during Q2.
The fact remains that Netflix, despite its management's inability to forecast anything, has high but consistently slowing growth in new subscribers. Three years ago, Q2 growth in paid subscribers was 27%, while this past quarter it was just under 22%. The long-term trajectory, in other words, is a slowing down of Netflix's growth.
There is a maturation, but it comes as Netflix is becoming a more everyday, more integral part of people's consumption of video. It's common to hear members of the younger demographic rattle off the shows they're watching: "Mindhunter," "The Good Place," "GLOW," "Stranger Things," etc.
Gen Z viewers are also apt to talk about binge-watching back episodes of "Friends," of all things. Catalog titles -- in other words, shows from thirty years ago -- remain a contributor to Netflix's viewership despite that catalog constantly losing high-profile assets such as "The Office."
For Q3, Netflix has set what some bulls fear is an overly-ambitious forecast to add seven million paid streaming members. And there is a concern that results in Q4 could be held back by Disney's (DIS) - Get Report release of its new streaming video service, "Disney+," which will start up in December.
Will Netflix whiff again? Quite possibly. This is the company that can't forecast, remember.
But the fundamental fact remains the company is paying almost nothing to borrow to build out content and distribution of that content. In addition to $8.4 billion in "content obligations" sitting on its balance sheet, it has another $10.1 billion in off-balance-sheet obligations to try to make money off of somehow. That pile of liabilities has remained consistently high for quite some time.
Someday, the tab will come due on those borrowings, and it won't be good for Netflix. But that day is not today. For the moment, subscriber additions will continue to fluctuate wildly, but generally up and to the right.
That means uncertainty in any quarter, including the current one, but a general continuation of the see-saw pattern that has also pushed Netflix stock up and to the right. Until the music stops and the Fed takes away the bunch bowl, the stock is a buy on these kinds of dips.
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Tiernan Ray neither trades nor owns any shares of any companies mentioned in this article.