Netflix’s Blockbuster Q4 Proves 'Smart Money' Exists

Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The term “smart money” has always annoyed me, but not for the reasons that you think. However, after Netflix (NASDAQ: NFLX) posted solid Q4 results on Wednesday, I was forced to take a whole new perspective on what the term means. And if it can be applied to anyone, Carl Icahn now tops my list.

The Smartest Guy in the Room

In November, the billionaire investor purchased a 10% stake in Netflix. However, the majority of his position in the movie giant was acquired via call options that are due to expire in September 2014. Although this has the same effect as an outright stock purchase, it’s important to note that this is different. Plus Icahn has the option to exercise his share purchases whenever he wanted.

This move didn’t make Netflix CEO Reed Hastings happy since Icahn has a history of hostile takeovers. Although we are far from this point with Netflix, don’t assume that this was not Icahn’s main objective, seeing as Netflix was in a freefall when he established his position. Netflix, which traded at over $300 just over a year ago, had cratered to $52.

Then shortly thereafter, Netflix announced a content sharing deal with Disney (NYSE: DIS) that will allow Netflix subscribers to stream not only Disney movies, but also those from subsidiaries such as Pixar and Marvel. Essentially, Icahn’s timing was impeccable -- on the news, shares of Netflix spiked up almost 10%.

Meanwhile, the deal with Disney negated a potential threat from Amazon (NASDAQ: AMZN), which signed a similar deal with Epix a few weeks before. Although details of the Disney agreement are still unconfirmed, estimates suggest that it is worth close to $300 million per year once it takes effect in 2016. As great as a catalyst this was for Icahn, it got better.

On Wednesday, following Netflix’s thrilling earnings report, the company sent a letter to shareholders disclosing that Icahn’s 10% stake in the company was established at roughly $58 per share. As of this writing the stock is trading at $144 in pre-market trading – up close to 40%.

Now let’s do the math: Icahn spent (roughly) $321.4 million for a 10% stake of Netflix, or 5.5 million shares at $58. With the stock now at $144 -- representing a gain of 148% -- this means that Icahn’s bet is now worth $800 million. That’s a pretty nice return for just two months of work.

In the letter to shareholders, Netflix added, “We have no further news about his [Icahn’s] intentions, but have had constructive conversations with him about building a more valuable company.”

In other words, “smart money” wins again and Icahn was the smartest guy in the room. But I would be remiss without crediting Hastings for this performance. Then again it was not a surprise. Going into this year, Netflix was at the top of my list of turnaround candidates.

How Did It Happen?

In an article titled, Netflix (Part 2): Is The Company Its Own Best Sequel, I discussed what the company needed to do to execute a turnaround – chiefly, the company needed to stop losing money each quarter and taper its grow at all coast mentality. Remarkably, this happened much quicker than anyone expected. Ahead of the report, in discussing expectations, I said the following:

“First and foremost, Netflix is going to report a loss for the quarter. Let’s just get that out of the way. The question is the magnitude. The Street expects a loss of 12 cents per share on $935 million in revenue. This would reverse a profit of $35.2 million, or 64 cents per share which the company earned last year.”

I was wrong. Not only did the company beat its revenue number by posting $945 million (up 8% YoY), but Netflix surprised the Street with a profit of 13 cents per share – analysts were expecting a double-digit loss. Impressively, Netflix continues to grow subscribers at an impressive rate – adding 2.05 million domestic streaming subscribers plus 1.81 million outside the U.S.

Better still, improving margins were seen across each reporting segment. This includes on a consolidated basis, which takes into account certain unallocated costs. Expenses continue to be concern however – albeit not as glaring. The company reported a 2.7% increase in marketing expenses and technology costs were up 1.7%.

In a surprising sign of cost management, general expenses declined by 30%. But that net income dropped 77% raised some red flags as EPS arrived 13 cents versus 64 cents last year. Then again, nobody expected a profit either. Besides, the situation is not as daunting since Amazon also lost $274 million in its recent quarter.

Bottom line

Overall, this was a impressive quarter. And investors are beginning to appreciate the capabilities of Netflix after the company was essentially left for dead at $52 per share. This proves that what was once great can be great again. And it also proves that “smart money” is considered smart for a reason. It remains to be seen where the shares end up after this excitement is over. But certainly it is clear that as in the movies when a hero falls or a hated villain dies, Netflix is back with a vengeance.

rsaintvilus has no position in any stocks mentioned. The Motley Fool recommends, Netflix, and Walt Disney. The Motley Fool owns shares of, Netflix, and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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