Netflix Is Still Headed Lower

 | May 08, 2012 | 1:01 PM EDT
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Did somebody get the number of the truck that hit Netflix (NFLX)?

The stock has been decimated and it's trading like its headed back to the 2012 lows. But I don't think it will stop there. Look, I know everyone's favorite price target on Netflix is $110, but I think the stock is headed to the mid $50s. Netflix faces a whole series of challenges that will keep the stock under pressure.

After Netflix reported its Q1 fiscal 2012 results on April 23, comments management made on the conference call slammed the stock. Specifically, management said the company lost some momentum due to seasonality. Warm weather during the quarter forced Americans get off the couch and go outside.

While the better-than-expected weather may have had some impact, for a company with a forward price/earnings ratio of 32 and selling for 6x book value, I really don't want to hear excuses. I want subscriber growth. The company also hinted that a larger subscriber base implies more churn. Really? To me, if customers were satisfied with Netflix churn would be declining regardless how many subscribers the company has. Stubbornly high churn tells me customers will jump to a competitor in a flash.

Second, the company talked about content costs. Aggressive spending to acquire fresh content, especially exclusive content, will continue to grow.  The company has some $3.6 billion of streaming obligations off balance sheet and those chickens will come home to roost one day. Most of those obligations are due within the next three years, so Netflix better find a way to become more profitable since it only has an operating margin of 8.1%. It wasn't that long ago that Netflix boasted a 14% operating margin. While operating margin has tumbled, free cash flow is circling the drain. The company once had upwards of $300 million in free cash flow. Now it's down to $180 million. With increased competition and lots of looming obligations, one has to wonder how they are going to pay for all of it. 

Yesterday, value maven Whitney Tilson was on TV professing that Netflix was a buy because the company is a likely takeover candidate. To him, the brand name plus some 26 million or so subscribers for $5 billion seems like a bargain.

Yeah, it's a great brand. But who is going to step up and pays a big premium for Netflix? I just don't see it.

Netflix has led a charmed life without much competition, but things are changing.

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