Tuesday, October 15, 2013

Netflix (NFLX) - How a New Industry Giant Shows 'Cheap' (?) Earnings Volatility into Earnings; Did You Know This?

NFLX is trading $324.47, up small with IV30™ down 1.4%. The LIVEVOL® Pro Summary is below.

Netflix, Inc. (Netflix), incorporated on August 29, 1997, is an Internet subscription service streaming television shows and movies. The Company’s subscribers can watch unlimited television shows and movies streamed over the Internet to their televisions, computers and mobile devices, and in the United States, subscribers can also receive digital versatile discs (DVDs) delivered to their homes.

This is an earnings volatility note on NFLX, an remarkable phenomenon that I see right now. I have written fairly extensively on NFLX, and how they have changed the entertainment industry and turned it on its ear. While this article focuses on the earnings release on 10-21-2013 AMC, I have included the prior posts below. Simply click on the title to read a specific post.

9-18-2013: Netflix (NFLX) - The New Giant -- Stock Near All-time High but Volatility Collapses to Multi-year Low

9-10-2013: Netflix (NFLX) - Is this the Most Powerful Firm in Entertainment? Some Things I Bet You Didn't Know... But Want to.

4-25-2013: Netflix (NFLX) - Vol Nears Multi-Year Lows as Stock Explodes; Hollywood Take Note -- Another Shot Across Major Distributor’s Bows

Here is a quick review from the most recent posts, which is highly relevant to this up coming earnings release.

So why is this happening to NFLX? Well, a lot of reasons, but one of the biggest is pretty simple:

NFLX now decides which TV shows are hits. Yeah, that's right. For example, the AMC original show Breaking Bad, the highest rated TV show ever by meta critics, was at a point after season 4 where its record viewership for any one episode was ~1.5 million people. That's actually very low. CBS has nights where shows hit 20 million. The Walking Dead (also on AMC) hit over 12 million. So, Breaking Bad, though a bonanza on the critical side, was actually kind of a poor performer in terms of viewership. Then NFLX happened.

An agreement was struck to put all of the "Breaking Bad" old seasons on NFLX for free (everything is free on NFLX with the monthly subscription). The first episode of season 5 aired to 3 million viewers (so a 100% increase). Then, the first episode of season 5 part II aired to 6 million viewers (NB: My numbers may be off wrt which season the bump(s) happened, do some fact checking before quoting me). OK, OK, is this really b/c of NFLX? Well, here's a direct quote from the show's creator, Vince Gilligan:
"I am grateful as hell for binge-watching. I am grateful that AMC and Sony took a gamble on us in the first place to put us on the air. But I'm just as grateful for an entirely different company that I have no stake in whatsoever: Netflix. I don't think you'd be sitting here interviewing me if it weren't for Netflix. In its third season, Breaking Bad got this amazing nitrous-oxide boost of energy and general public awareness because of Netflix."

Why does this matter? How about this... Instead of NFLX paying for content, the content providers may pay NFLX to air their shows. That's incredible.

Add to the fact that NFLX now has critically acclaimed original content -- that's content available ONLY on NFLX ("House of Cards" and "Orange is the New Black" are two of them) and what we're slowly finding here is that NFLX may become the most powerful content distributor for TV (the profitable part of the entertainment business) on the planet.

Don't laugh or roll eyes, it's happening right now. FOX is tying the same game as AMC did with "Breaking Bad" with their sitcom "The New Girl." And you know what?... it's working again...

Now NFLX does have competitors, namely AMZN (I know they're not the first name to come up from entertainment industry folks, but the entertainment industry is wrong -- AMZN is the risk for NFLX). Another risk is the content creators using their own channels (no pun intended)... but that doesn't seem to work so far (and yeah I know what Hulu is and who created it).

Here's more news, from CNBC a day after I posted this article:
Groundbreaking news that Virgin Media is bringing Netflix directly to its set-top box in the U.K. in effect elevates Netflix to the status of a new cable network-a benefit for a cable company and beyond being an upstart threat to cable.

The deal, which makes Netflix available on cable set-top boxes for the first time, was announced Monday. On Tuesday, Netflix shares hit a new all-time high, trading 6.5 percent higher to $313, flying past its record $304 on July 13, 2011.

The stock's nearly 220 percent gains this year have been driven largely by the success of its original content deals, which have helped add new subscribers, giving Wall Street confidence that exclusive originals will continue to deliver.

(More from Julia Boorstin: Is Apple's iRadio a Pandora killer? )

Virgin's parent, Liberty Global (LBTYA), gained just under a percentage point on Tuesday's news.

Virgin Media's partnership with Netflix is the first time a cable operator is bringing the streaming service directly to the set-top box. Other cable operators-like Comcast (CMCSA)-allow users to access Netflix through Internet-connected set-top boxes-but this is the first time a cable channel has directly made a deal with Netflix to treat its content just like that provided by cable channels like HBO (owned by Time Warner (TWX)) and Showtime (owned by CBS (CBS)). (Disclosure: Comcast is the owner of NBCUniversal, the parent company of CNBC and CNBC.com.)

Virgin will integrate Netflix with its television content so it's easy to seamlessly browse and search across both TV and streaming content.

Source: CNBC via Yahoo! Finance Why Netflix is at a new all-time high, written by Julia Boorstin.


OK, so all of this has seen NFLX stock go from a low of $57.40 in the last 52 weeks to now trading at ~$325. And this is a $19 billion company, not a tiny $50MM market cap that has moved 600%.

Let's turn to the two-year Charts Tab, below. The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue vs HV180™ - pink).

On the stock side, we can see that breath taking rise.  A complete reversal of fortune of a firm on the brink of a solvency and relevancy catastrophe, to a firm that may be worth $100 B in a few years.

OK, but this is a volatility note, so let's turn to an isolated two-year IV30™ chart below.

NFLX has earnings due out in less than a week.  What I have done is highlighted the IV30™ over the last eight earnings cycles (the blue "E" icon represents an earnings date).  Two things to note:

(1) We can see a steady decline in the earnings volatility peaks.. OK, semi-interesting.

(2) Most interesting (to me) is how low the implied is right now relative to the other peaks. I have drawn that horizontal yellow line from the current volatility level back two years.  It's shocking (to me) how depressed the earnings vol is right now relative to the last eight quarters given the remarkable (and surprising) news that has come out of this firm's earnings releases in the past.

Bottom line, this feels like way too low volatility, especially considering that earnings are due out on 10-21-2013, and Nov expiry is Nov 15th.  So, in English, the owning the IV30™ into earnings gets both an earnings release and another four weeks of "regular" stock movement.

Finally, let's turn to the Options Tab for completeness.

Across the top we can see Nov vol is priced to 64.70%.  The lowest volatility into the last eight earnings cycles was 74% and the second lowest was 77%.  The highest volatility into earnings over the last eight quarters was 134%, and second highest was 90.83%.

Right now the ATM straddle in Nov costs ~$50, so it dollars, it ain't cheap.  The question is, do you think NFLX will move by more than +/- 50 at any point between now and Nov 15?  or, do you thin volatility will rise enough to make that straddle worth more than $50 at any point between ow and Nov 15?  Fair question... Or is it 'fair?'

This is trade analysis, not a recommendation.

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