Netflix (NASDAQ: NFLX) Looks Like a Sell as Conditions Shift

There was little doubt that Netflix (NASDAQ: NFLX) was going to walk out of the second quarter on top of the world. It had exactly what people needed in the second quarter, and was ready to deliver it up to as many comers as were interested. The question was, could it possibly carry on that way in the third quarter? As investors gathered to see just what the numbers looked like out of Netflix's second quarter, the answer increasingly looked like “not a chance.”

Netflix report that fell short

Netflix hit the market at the closing bell last night to present its earnings report, and even ahead of that, options buyers were looking for a big move one way or the other. Some reports projected that the stock price could swing as much as $50 one way or the other, and a substantial number were moving into the “all-time high” betting camp.

That's why the numbers Netflix released had to be such a shock. The company brought in a massive slug of new users as those forced to stay home by government mandate looked for something to do, and found Netflix waiting. Despite this, however, the company's earnings profile was merely mixed news; the company beat the Refinitiv revenue estimates, coming in at $6.15 billion against an expected $6.08 billion. The company also shattered expectations on net subscriber additions worldwide, coming in with 10.09 million subscribers against an expected 8.26 million. It lost, however, on earnings per share, coming in at $1.59 against an expected $1.81.

The reason for the shortfall on earnings per share, reports noted, was related to issues of “research and development tax credits” out of California.

The show Netflix put on was impressive, and no mistake; it delivered on two out of three key points and probably would have had a third if it hadn't been for those tax issues. The problems for Netflix kicked in when it started talking about the third quarter, and how there was pretty much no way it could repeat the second quarter.

It's easy to forget that Netflix's massive rise came on the back of a specific set of conditions that are unlikely to occur again. First, there was the obvious: a pandemic with outcomes so unclear that virtually all of the United States shut down for about a month and a half. Then, a pandemic that became so politicized that half of the country stayed shut down for at least two more weeks after that.

As states started their patchy reopening, and people went back to work on various fronts, the sheer bulk of time that's required to be a Netflix subscriber and actually get the most out of it fell off, which made Netflix's third-quarter look like a dumpster fire against the incredible gains of the second. Netflix's third-quarter still looks objectively good, with an expected revenue of $6.33 billion and 2.5 million net subscriber additions, but this is all below analyst estimates of $6.4 billion and 5.27 million net subscriber additions. Compared to the stellar second quarter, it's almost a disaster.

Netflix Troubles Don't Stop There

While Netflix is returning to something like normalcy and taking its dazzling gains with it, there are further troubles lurking in the background. Two new lawsuits have emerged to take on Netflix; comedian Mo'Nique has been allowed by a court to pursue a discrimination lawsuit against Netflix overpayment for her stand-up special in 2017, and a newer lawsuit has emerged targeting one of Netflix's flagship series, “Stranger Things,” citing copyright infringement against an earlier screenplay called “Totem.”

However, Netflix isn't taking the likely loss of subscribers coming up lying down; it's launched a contest around the video game “The Old Guard,” offering the highest scorer on the planet a free subscription with a term of 83 years. It's also recently dropped a new series based on Arthurian legend known as “Cursed,” which will be a valuable commodity in an entertainment market where new series are all but impossible to find right now thanks to the coronavirus shutting down production.

Essentially, it was a foregone conclusion that Netflix couldn't have another quarter like it just had. The conditions that created it are pretty much over. The idea of wide-scale lockdowns is still a possibility, but as states survey their ruined budgets for 2021, it's likely going to take a lot to pull that trigger again. Netflix is still a fairly attractive commodity in streaming video—one of the clear leaders—but taking profit on this one and waiting for a better re-entry point is probably going to be the best strategy long-term. The party is over for Netflix...at least, for now.