BOSTON (CNN/Money) -
Malcolm X once famously said, "You're either part of the solution or part of the problem." To Netflix, I think I'm both.
I'm part of the problem because I'm considering canceling my Netflix (NFLX: Research, Estimates) subscription. I recently signed up for Comcast's DVR box, and with the same three Netflix movies sitting on top of my entertainment center for about a month now, I'm thinking I could more wisely spend the $21.95 monthly subscription cost.
But I'm apparently part of the solution too, at least for investors. Because I haven't been shipping movies back to the local Netflix warehouse at a regular clip, I helped the company save on postage charges. If I rent fewer movies, then profit margins rise as shipping, handling, and other costs fall.
Apparently there are a lot of folks like me -- so many that the company boosted its profit guidance on Oct. 4, citing lower-than-expected postal expenditures. Net profit will be as high as $17.5 million, the company said, compared with the earlier forecast of $6.7 million to $10.2 million.
At the same time, Netflix announced it had recalculated the useful life of its catalog of DVDs to three years from one to three years. A longer productive life for each DVD means the company is earning a higher return on its capital investment, which in turn will boost earnings 4 percent per quarter. Investors liked the news, sending the stock up 11 percent in after-hours trading that evening.
But as the news began to sink in, investors started to question the announcement. Is cancellation the next step for people who aren't shipping movies back and forth regularly? And was the sudden amortization shift just accounting hocus-pocus?
"We were troubled by the announcement," says Alden Mahabir, an analyst with Vintage Research who has a "sell" rating on the stock. "We believe the earnings increase was manufactured, and it appears the company arbitrarily classified what was an old and new movie." When Netflix announces third-quarter earnings on Thursday, smart investors will be listening to the question-and-answer portion of the conference call for more guidance on the company's fundamentals.
After all, it's been a rough quarter for Netflix. The stock started off near its 52-week high of $39.77, but now it's trading closer to its 52-week low of $13.85.
When rumors of a deal to distribute movies via TiVo (TIVO: Research, Estimates) machines were widely publicized, the stock saw a small boost, but overall it has been sloping toward the bottom right corner of the stock chart during the past three months. Which is strange given that many of the company's fundamentals are very strong:
Netflix now has 2.23 million subscribers, up 73 percent from 1.29 million a year ago, and is carrying only $253,000 in debt.
So what gives?
Well, there are some out-of-whack fundamentals, such as its trailing price/earnings ratio of, oh, 880 near its 52-week low. What's more, just over half of the stockholders are shorts, who buy borrowed shares in a bet the stock will drop. With a relatively small float of 36.8 million shares, this stock can whipsaw like an Exxon sign in a Florida hurricane.
Still, I believe the recent dip represents a buying opportunity. While Netflix isn't out of the woods yet, it has held its own against Wal-Mart (WMT: Research, Estimates) and Blockbuster (BBI: Research, Estimates).
In fact, it has grown steadily despite the encroachment. What's more, the company's reasoning for the recent decrease in movie rentals -- that it was because of the Summer Olympics -- bears out. Says Dennis McAlpine, managing director of McAlpine & Associates, "It's affected the home video market for years." And given the fact that 70 percent of all Netflix rentals are "library titles," not newer fare, the longer amortization schedule makes sense.
Which is all to say that I think investors wrongly put a negative spin on the announcement. If management assuages investor concern regarding title rental declines, I believe the stock could reverse its recent downward trend.
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