Netflix Opened The Door For Short Sellers With One Sentence From Its CEO

Netflix stock is up 17% after the company released an earnings report on Tuesday that exceeded Wall Street’s expectations for the company’s most crucial metric — subscriber growth.

The company reported 54.5 million streaming paid members and 57.4 total members; 2.43 million international subscriber adds vs. 2.1 million estimated — a great report for the longs.

But it was also a great one for people who think Netflix stock is overvalued. One sentence from Netflix’s earnings statement is all you need to understand why.

Here it is:

“We then intend to generate material global profits from 2017 onwards.”

On page 3 of its earnings release, Netflix set a due date for its profitability, calling an end to its era of expansion in the next two years.

“Our international expansion strategy over the last few years has been to expand as fast as we can while

staying profitable on a global basis. Progress has been so strong that we now believe we can complete
our global expansion over the next two years, while staying profitable, which is earlier than we
expected” — and then the crucial sentence — “We then intend to generate material global profits from 2017 onwards.”

Investors are going to start to want to see profits, and Netflix will have to deliver. This is a big transition for any company, and it’s hard to nail the dismount cleanly.

So can Netflix be profitable in two years? That’s a tough one. It hasn’t done it yet, and the bear thesis is that company is scaling too fast and burning through cash. The company said that it expects lower income in 2015 too, so part of this is going to be about controlling costs in a pretty expensive business.

This quarter, Netflix was cash flow negative by $US78 million. It missed revenue estimates bringing in $US1.48 billion vs. $US1.49 billion analysts were looking for. Shorts will be watching the former, especially, very closely.

House of cards season 2 frank underwoodNathaniel Bell for NetflixLike the shorts, Frank Underwood is always waiting for the big payoff.

They will also be watching margins in the US market. That’s where Netflix set a few targets going into 2017:

We have built in flexibility to our business model in terms of how quickly we grow content and

marketing spend, so we intend to keep US contribution margins growing even with lower membership

growth. This year we plan to increase US contribution margins from 30% in Q1 to about 32% in Q1 2016

to about 34% in Q1 2017, etc.

It’s worth noting that from the end of 2013 to the end of 2014, Netflix’s US streaming margins have grown 5%.

The company didn’t disclose margins for its DVD rental business in the US, but (as you might suspect) that whole business is on the decline having gone from 6.3 million subscribers in the second quarter of 2014 to 5.8 million in the fourth quarter of 2014.

Another dark spot — the company’s international streaming business has been a consistent loser, losing $US79 million in the fourth quarter of 2014. The company expects it to lose $US62 million in the first quarter of 2015.

Meanwhile Netflix’s streaming content obligations, which are signed whenever they get a licence to a new title, have ballooned to $US9.5 billion in the fourth quarter of 2014 from $US7.3 billion at the same time a year before.

But you’ve got to feed the beast. And if people want more content, you’ve got to give them more content or they will leave you. It’s a delicate balance.

A politician once said, ‘never make a promise and give a date in the same sentence.’ He was right. It is dangerous unless you’re certain you can fulfil the former on the latter, especially in business.

For today, though, things are looking amazing.

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