Few stocks better showcase Wall Street's ability to turn on a dime, from love to hate, than the stock of Netflix (NFLX) . The shares are down more than 35% following the earnings report on Wednesday. It's tempting to think Wall Street has it wrong again, this time to the downside. In the wake of 10 analysts' downgrades, the selling is emotional, with owners just wanting the name off the books. Bill Ackman sold his entire 3 million share position in one day, booking a $430 million short-term loss.
Has the Netflix story changed so dramatically overnight? Wall Street sees the stock in purgatory -- the classic end to a growth story -- a stock jettisoned by growth investors and still too expensive for value investors.
In these situations, I respect the force of the selling, the wholesale bailout as assumptions and growth models have changed. Yet, the contrarian in me considers scooping up shares on a possible overreaction. That the stock is down 70% from the highs means little. The assumptions, hype, and market froth that helped the stock trade to $700 seem irrelevant now. Knowing how negative the sentiment has turned, the stock will have difficulty sustaining oversold rallies.
Nonetheless, a fresh look at NFLX is justifiable.
First, let's look to an analyst who had been skeptical of Netflix's stock valuation and business model, Laura Martin from Needham. Although she upgraded the stock to neutral on Wednesday, her research still reads skeptically.
"Netflix will NOT be a Streaming Wars winner (our view) unless it adds sports and news content (to lower customer acquisition costs), buys a deep film and TV library (to hold onto subs longer), and enhances its bundling opportunities (to lower churn). Also, NFLX's single pricing tier is much too expensive compared with every streaming competitor that has a $5-$7/month (or free) ad-driven streaming option. We believe NFLX growth will not return until it adds an ad-driven tier priced at $5-$7/ month, to maximize its top-of-funnel" total addressable market, she wrote.
The laundry list from Laura Martin shows that execs have their work cut out to reverse the tide. By Netflix management's admission, it's now a "show-me" story and no longer a "tell-me" story. Considering the current market's lack of patience for tech stocks, the stock can drift lower after the oversold bounces run their course. This keeps me on the sidelines for now.
Management has levers to pull to creatively improve the appeal of a powerful streaming platform and reinvigorate growth. Netflix has had one model with limited pricing tiers; various new formulas are likely to optimize the service for many users. Advertising coupled with high-quality video is in demand from advertisers. Plus, demand for a lower-priced tier is high. The ad model can even result in a higher average revenue per user. Also, expect Netflix to address password sharing, probably after more pricing options are in place.
When the pendulum swings on Wall Street, from over-loved to loathed, the narrative becomes unduly negative, and stocks can go lower than imagined. From Netflix's history of resurrecting after Wall Street has counted it out, a case can be made to start tuning into the shares, currently at 3-times revenues and a 20 price-to-earnings. But given an unforgiving market for tech, a full washout to a more attractive buying opportunity is also likely. Patiently waiting for lower levels below $200 is a reasonable game plan until Netflix demonstrates a clear path to continued growth.