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Formulaic plot

16 October 2014 By Jeffrey Goldfarb

Netflix is sticking to the script. The film and TV streaming service lost $7 billion of market value in after-hours trading on Wednesday following news that it had signed up fewer new subscribers last quarter than originally forecast. Even for one of the most-shorted and volatile stocks, a 25 percent decline is notable. And yet investors have seen this movie before.

All the familiar frights were on display. The cost to Netflix of buying and creating new programming – including its first original movie “Crouching Tiger Hidden Dragon: Green Legend” – keeps rising. The tally increased to $8.9 billion at the end of September from $7.7 billion at the end of June. That, along with the price of overseas expansion, meant free cash flow turned negative again. Then there’s Netflix’s demanding valuation. Even after the sell-off, the shares trade on a head-spinning multiple of 86 times earnings for the last 12 months.

Most of the expected thrills repeated, too. The company’s U.S. streaming “contribution margin”, which excludes certain costs like technology development, rose to 28.6 percent, up 5 percentage points from a year ago. Netflix is aiming for 40 percent in about five years. Higher prices may have stung, but the company keeps adding a healthy number of new subscribers, who it says are watching more and sticking around for longer. It also secured seven Emmy Awards and has signed new deals with comedy stars Adam Sandler and Judd Apatow.

Just as it has withstood market convulsions in the past, Netflix is bound to fight through this latest one. Rival services from Blockbuster, Wal-Mart and Amazon have all supposedly spelled doom for Netflix at one time or another. So too have surprisingly high marketing costs and unexpectedly low revenue in quarters past. Netflix even overcame a fitful attempt to split its DVD and streaming businesses by reversing the decision.

The latest imagined existential threat might be a stand-alone version of rival HBO. And yet Netflix shares hardly budged after Time Warner announced that decision early on Wednesday, when investors were also worrying about a global slowdown. That may have been the only real surprise in the Netflix story.


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