Netflix eyes new record high on subscriber surge

Netflix underpinned investors’ revived taste for big technology shares on Monday night after the streaming pioneer unveiled new subscriber numbers that were far higher than the most optimistic forecasts.

No cash flow, no problem, it seems

Whilst Wall Street has over the last few quarters attempted to usher Netflix into more conventional performance yardsticks – seeking more consistent progress on revenues and profitability – an ebullient stock price reaction to the announcement of 5.2 million new subscribers, compared to about 3.2 million expected, shows the group’s broader investor base still sees it as firmly in the 'growth' camp. That implies continued forgiveness of only intermittent top and bottom line progress and tolerance of Netflix’s ongoing negative cash balance. It probably surprised no one last night by confirming that it expected to be free cash flow negative for "many years". Even so, the 11% stock price surge in specially extended trading is almost certain to carry over into Tuesday’s main session and has implications well beyond the next few days.

The ratings

Netflix’s statement in a post-earnings letter to shareholders that it expects international subscriber additions of 3.65 million for the current quarter (Q3) compared with the average estimate of 3.2 million before the Q2 release is the first official substantiation for months that the group’s still demanding forward rating has not become completely implausible. Even after tumbling from levels two years ago suggesting investors were willing to pay almost $500 for every dollar of Netflix earnings over the next 12 months, its price/earnings ratio is still around 100 times earnings forecast for the year ending in Q2 2018. That’s ultra-demanding given that Netflix profits are still ‘messy’. For instance, Q2 EPS of $0.15 (or $65.6m in total net income) was actually slightly below consensus forecasts, and even then only got there due to a higher-than-expected tax benefit that offset a $64m non-cash unrealized loss. Revenue rose 32.3% to $2.79bn.

Stream of buyers

Even so, having closed last night about $5 away from its latest all-time high, post-earnings momentum could see the share challenge the same price on Tuesday and even retain enough momentum to sustain gains. That would extend a long, albeit not unbroken rally from a low of just under $80 in February 2016. Indeed, if the stock rises by the same amount on Tuesday as seen after hours on Monday it will set a new record high. An influx of options buying just hours ahead of Q2 figures—at circa 165,000, twice the daily average volume—showed speculators were betting the stock would move no less than 8% up or down in the wake of its figures by Friday. That compares with the stock’s 9.8% move on average a day after Netflix last 8 earnings, crunching Reuters’ numbers.

Like a House of Cards?

Last night’s stock jump and its possible extension show that the group’s frequent attempts—including on Monday—to talk down irrepressible expectations and warn about risks to financials are falling on mostly deaf ears. Netflix said it anticipated free cash flow would be in the red by $2bn-$2.5bn in the current financial year. Somewhat balancing that, it did say it expects overseas markets to mark a first year of profit in 2017, as it moves away from teething problems over customising content for overseas audiences with successful shows in various languages. That doesn’t mean overall profitability is anywhere close though. Nor will it be for the foreseeable future: Netflix burned through $608m in Q2, up 44% on the year and is expected to torch as much as $2.5bn in 2017. Its planned spend on TV series and films this year is in fact at least $6bn as it continues fight off rivals—successfully so far—like Google and Amazon.

Shareholders have again demonstrated willingness to keep funding Netflix’s global movie and TV ambitions, almost regardless of the cost, but for how long? With a net margin that will struggle to reach double digits by 2020, far thinner than conventional broadcasters, subscriber growth would have to sustain Q2’s exceptional level to justify long-term ratings. The stock’s reputation for high drama still cuts both ways.

In the short term, traders may take comfort from the appearance in Netflix’s technical price chart of the same essential ‘fractal’ that is forming in virtually all large American tech stocks and indices like the Nasdaq Composite, the S&P 500 Information Tech index and others—a classic A/B/C/D Fibonacci continuation structure.

Technical analysts do not regard such manifestations as necessarily all positive though. In Netflix’s case, depending on how the pattern is drawn (I have chosen the conventional approach in the chart below) completion at point D would imply an additional down leg, assuming the prior up leg is complete after a 78.6% Fibonacci retracement of the last distinct down move. (In turn the latter corresponded well with the 78.6% interval of the initial X-to-A impulsive rise.) The discovery of symmetry in terms of Fibonacci intervals provides some backing for the notion that stability is returning to Netflix price action – as they do when seen in the other assets we mention above. However, the breadth of these retracements are beyond the 61.8% level generally regarded by chartists as signifying the normal run of advances and consolidation. That should keep an additional caution on the table regardless of whether the stock busts resistance created by its latest record high of 166.82, which seems likely to happen in very short order.

More positively, Netflix has just about maintained its long volatile uptrend, despite a wide swing that left the stock 4% in the red for the year earlier this month (it has subsequently recovered and stands 6% higher, year to date).

Stabilisation of the stock above the blue rising trend line that strictly speaking has been respected since November 2016, improves chances that the shares could soon settle into a smoother uptrend