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Netflix Stock Shoots to Record Highs as Investors Embrace Cash-Burn Strategy

For the next few years, at least, Netflix says it’s going to keep burning cash and raising debt as it focuses on content acquisition and international growth — instead of profits. And investors are cheering wildly over its Amazon-like plan to invest in getting huge.

After gaining a second-quarter record 5.2 million subs overall, 63% higher than Wall Street had forecast, Netflix crossed the 100 million subscriber mark during the three months ended June 30 to stand at 104 million worldwide.

The surprisingly strong subscriber growth pushed Netflix shares to all-time highs. The stock opened Tuesday up 9%, at $176.12, and by midday had crested $183 per share — up more than 13% on the day.

[UPDATE: Netflix stock closed at a record high of $183.60 per share, up 13.5%, having jumped 44% since the beginning of 2017. That gives it a market capitalization of $79.4 billion, making Netflix now more valuable than Time Warner (which has a market cap of about $76.4 billion).]

The investor fervor comes even though on the financial front, Netflix came in roughly in line with forecasts. It posted $2.79 billion in revenue (versus $2.76 billion consensus estimates) and actually missed earnings by a penny per share, reporting EPS of 15 cents versus analyst consensus 16 cents.

And investors are enthusiastic about Netflix continuing to spend like crazy. The company expects to have negative free cash flow “for many years,” Netflix said in the quarterly letter to investors. It forecast negative free cash flow of $2.0 billion to $2.5 billion for the full year 2017; previously, the company had projected negative FCF of around $2 billion for 2017.

In 2015, Netflix had negative cash flow of $920 million, which grew to $1.7 billion in 2016. The prospect of Netflix’s cash burn accelerating this year “is problematic,” Wedbush Securities’ analyst Michael Pachter wrote in a research note. “[We] remain unconvinced that Netflix’s content library is sufficiently robust to justify the over $13 billion value reflected on its balance sheet.” Pachter, a well-known Netflix bear, maintains an “underperform” rating.

Also skeptical is MoffetNathanson’s Michael Nathanson, who continues to maintain a “neutral” rating on Netflix. “We’ve watched this stock levitate like AOL (circa 1996 and 2000) and have stayed on the sidelines as we’ve struggled with valuing a company that willingly generates no free cash flow,” Nathanson wrote in a research note.

Unlike Amazon, which pursued the cash-burn path for many years to expand into multiple ecommerce segments, Nathanson wrote: “We just don’t believe that Netflix is building an impenetrable moat that justifies its $80 billion market cap.”

Netflix CEO Reed Hastings, speaking on the Q2 earnings interview Monday, actually gave a positive spin on the company’s rising cash-burn rate. “The irony is the faster that we grow — and the faster we grow the owned originals — the more drawn on free cash flow that will be,” he said. “So in some senses, that negative free cash flow will be an indicator of enormous success.”

On subscriber growth, Netflix continues to defy bearish expectations, RBC Capital Markets analyst Mark Mahaney noted. While some observers have warned that Netflix’s U.S. streaming business is near saturation — standing at 52 million domestic subs as of the end of Q2 — it turned in a big gain in the States in the June quarter, netting 1.07 million. Praising “one of the best management teams” in the internet sector, Mahaney reiterated his “outperform” rating.

“Our long thesis remains fully intact,” Mahaney said. As cord-cutting continues, there will be a “dramatic secular shift” away from pay-TV services, which have some 1 billion subscribers today, to internet streaming TV. “Netflix is the dominant subscription [VOD] leader – perhaps 8X more subs than the closest competitor, and this is a scale game,” the analyst wrote.

Also Tuesday, UBS analyst Doug Mitchelson — the only person allowed to ask questions on Netflix’s Q2 earnings interview — raised his price target on the stock from $175 to $190 per share. The analyst raised 2017 estimates for global net subscriber adds by 2.34 million, to 21.54 million (up 13% year-over-year). That will generate an additional $221 million in revenue and boost earnings before interest, tax, depreciation and amortization by $50 million (to $900 million, up 106% year-over-year), he estimated.

“We expect Netflix’s original content ramp to continue to drive accelerating international net additions, especially as Netflix increases investment in local content overseas and adds more movies and nonfiction genre content,” Mitchelson wrote.

With that strategy, Netflix continues to amass debt and long-term payment obligations on its books. As of June 30, Netflix had $4.84 billion in long-term debt (versus $3.36 billion at the end of 2016). Streaming content obligations — payments related to the acquisition, licensing and production of streaming content over a multiyear period — swelled to $15.7 billion, up from $13.2 billion in the second quarter of 2016.

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