Netflix Shares Got Crushed: What’s Next?

Yesterday, Netflix reported earnings and the company felt the full effect of customer dissatisfaction. It wasn’t too long ago that Netflix was a darling company in the eyes of both consumers and investors. However, no business is immune to bad decision making, misguided strategy, and a lack of customer orientation. Reed Hastings, CEO of Netflix, learned this rough lesson first hand.

Last month, Netflix pushed forward with an unpopular plan to separate the company into two entities: Quikster for mail DVD’s and Netflix for streaming video. Netflix also increased their monthly subscription fees, which is never a popular move.

These two hasty decisions resulted in some disastrous consequences for the company. Consumers vented on blogs and social media outlets about the pricier monthly fees. In addition, almost all consumers derided the decision to split the DVD service into a new company called Quikster.

Eventually, the drumbeat of angry consumers became too loud and Reed Hastings decided to cancel his Quikster plans. Although I applaud Reed Hastings for stepping up and righting his wrong, it appears that it may be too late. Yesterday, Netflix reported their Q3 earnings and the numbers tell the whole story.

CEO Reed Hastings has since issued an apology to Netflix customers, but the damage is done already.

The top video rental service had added at least 1,000,000 subscribers the past seven consecutive quarters prior to the most recent third quarter this year. However, in the three months ending September 30, Netflix actually lost 810,000 subscribers. Netflix reported 24.6 million subscribers in the second quarter and 23.8. million in the third.

Even though Netflix has already lost a significant amount of consumers, the implications on future cash flows is even worse.

Yesterday, Netflix released Q4 guidance of $0.36-$0.70/share, which well below Wall Street’s expectations of $1.09/share. The weaker than expected guidance caught investors by surprise and sent $NFLX shares into a total freefall. Shares of Netflix ($NFLX) crashed more than 36% in after-hours trading on weaker than expected guidance.

In July, shares of Netflix were trading above $300, but since then the company’s shares have surrendered 71% of their value. Clearly, the company is going through some major structural issues and the numbers don’t lie.

So is this huge fall from grace a once-in-a-lifetime buying opportunity for savvy investors?

Not so much.

Even though Netflix has lost 71% of their value in the last ~90 days or so, shares of $NFLX are still surprisingly expensive.

If you take the low-end of $NFLX’s Q3 guidance look at it on an annualized basis, it results in yearly EPS of $1.44. As of this morning, Netflix is trading at $74.00 per share, which results in a relatively high P/E ratio of 51.38. So even though Netflix has already lost a significant amount of value, the stock is still expensive from a valuation perspective.

Another factor is that Netflix has a very big perception problem with investors and customers. In the past few months, Wall Street investment banks have regularly slashed price targets and estimates on Netflix and that is likely to continue. When a company is going backwards, Wall Street analysts usually pounce on the opportunity and continue to downgrade the company.

My recommendation? I would not approach Netflix as a buying opportunity right now. If anything, I think this is an opportunity to press a short position in the near-term. The company is in serious turmoil and faces a huge perception problem among their customers and investors.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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