Netflix (NFLX, Financial) has served early investors very well for the last three years, when the share prices went up from around $20 at the beginning of 2008 to nearly $300 in July 2011, a jump of 15 times within 3.5 years, creating the annual compounded gain of more than 116%. However, from the top of nearly $300 per share, within just two months, the price has dropped nearly 50%, now staying at $155 per share.
The business is described in its annual report as the business of Internet subscription service for enjoying TV shows and movies. It has the subscribers who can instantly watch unlimited TV shows and movies streamed over the Internet to their TVs, computers and mobile devices and, in the United States, subscribers can also receive standard definition DVDs, and their high definition successor, Blu-ray discs, delivered quickly to their homes.
The core strategy of business is to drive subscriber growth, and from that to add more content, which in turn drives more subscriptions. Netflix obtains content from various studios and providers via fixed-fee licenses, revenue sharing agreements and direct purchases. In fiscal year 2010, the majority of subscribers to Netflix were viewing TV shows and movies via streaming than the traditional DVD. The firm believed that the main business is in global streaming, with the added feature of DVDs by mail in the U.S.
Whitney Tilson has written an article on the reason why he shorts Netflix, when its share price is around the range of $180 a share. The businesses he prefers to short normally fall into the categories of “outright frauds (our very favorite), industries in decline or facing major headwinds, lousy or faddish business models, bad balance sheets, and incompetent, excessively promotional and/or crooked management.”
He doesn’t want to short a good business even with a high valuation. However, if the valuation becomes too expensive, he thinks a little misstep would trigger a significant sell-off in the stock. And the latter is the case for Netflix. He thinks that Netflix's future depends on its streaming video business (not DVD by mail), but its streaming library is weak, resulting in declining usage and subscription. And that could lead to Netflix having to pay large amounts to license more content, which would dampen the margin and profit.
In a survey of more than 500 Netflix subscribers posted in the value investing letter, the majority of subscribers do one DVD at a time plus streaming; more than 50% have been customers of Netflix for two years; and 63% have not ever stopped the subscription. An equivalent percentage of people feel highly satisfied with the DVD rental services offered by Netflix. With the streaming services, 36% are highly satisfied and the same percentage is moderately satisfied. With respect to competitors, there are two main other services which other people subscribed to: ITunes and Hulu.
However, two months after releasing the paper for about his short position in Netflix, he wrote an article on covering the short position when the price was 25% higher than in December 2010, at $222 a share. But he will not buy Netflix at this price. I personally think it was a smart move for Tilson at that time as God knew when the share price was going to fall, and the stock still had good momentum with all good operating results, but the belief in a falling price with such rich valuations is quite firm.
As predicted, after reporting a jump in profit in the fourth quarter 2010 pushed the shares higher, CEO Reed Hasting decided to raise the rate for the price of renting one DVD at a time and for unlimited streaming from about $10 a month to about $16 per month. Then Netflix lowered the third quarter forecast by 1 million subscribers, from 25 million to 24 million. The expectation that DVD-only subscribers are down from forecast 3 million to 2.2 million, and streaming-only subscribers are from 22 million to 21.8 million. In addition, Netflix has too much difficulty obtaining more content, as the agreement with Starz, the provider of hit movies such as Toy Story 3 and several TV shows including Spartacus, has come to an end. Starz will not provide TV series and movies to Netflix after February 2012.
Now I think it is the best time to begin shorting Netflix, with the combining of two forces: One is fundamentally high valuation represented in the stock price, and second is the negative momentum happening in the stock price caused by the downward adjustment forecast in the business performance. That results from the discontinuation with one of the good hit movies and series content provider, and the restructure in the business operation along with the rising rates for DVDs. The customers have to pay more for DVDs to get less in streaming than they had before. That’s the destruction in customer service and business models.
In the longer term, it is hard to determine who’s going to be the winner in the streaming business: Hulu, ITunes, Amazon or Netflix. It is all about how the management plays out in the game with its competitors, and the cost effectiveness to obtain premium content and the value it gives to its subscribers compared with the fee they have to pay. Currently, the future is not very bright for Netflix; with the high valuation, it is definitely not a buy, but rather a stock to short.
This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.
The business is described in its annual report as the business of Internet subscription service for enjoying TV shows and movies. It has the subscribers who can instantly watch unlimited TV shows and movies streamed over the Internet to their TVs, computers and mobile devices and, in the United States, subscribers can also receive standard definition DVDs, and their high definition successor, Blu-ray discs, delivered quickly to their homes.
The core strategy of business is to drive subscriber growth, and from that to add more content, which in turn drives more subscriptions. Netflix obtains content from various studios and providers via fixed-fee licenses, revenue sharing agreements and direct purchases. In fiscal year 2010, the majority of subscribers to Netflix were viewing TV shows and movies via streaming than the traditional DVD. The firm believed that the main business is in global streaming, with the added feature of DVDs by mail in the U.S.
Whitney Tilson has written an article on the reason why he shorts Netflix, when its share price is around the range of $180 a share. The businesses he prefers to short normally fall into the categories of “outright frauds (our very favorite), industries in decline or facing major headwinds, lousy or faddish business models, bad balance sheets, and incompetent, excessively promotional and/or crooked management.”
He doesn’t want to short a good business even with a high valuation. However, if the valuation becomes too expensive, he thinks a little misstep would trigger a significant sell-off in the stock. And the latter is the case for Netflix. He thinks that Netflix's future depends on its streaming video business (not DVD by mail), but its streaming library is weak, resulting in declining usage and subscription. And that could lead to Netflix having to pay large amounts to license more content, which would dampen the margin and profit.
In a survey of more than 500 Netflix subscribers posted in the value investing letter, the majority of subscribers do one DVD at a time plus streaming; more than 50% have been customers of Netflix for two years; and 63% have not ever stopped the subscription. An equivalent percentage of people feel highly satisfied with the DVD rental services offered by Netflix. With the streaming services, 36% are highly satisfied and the same percentage is moderately satisfied. With respect to competitors, there are two main other services which other people subscribed to: ITunes and Hulu.
However, two months after releasing the paper for about his short position in Netflix, he wrote an article on covering the short position when the price was 25% higher than in December 2010, at $222 a share. But he will not buy Netflix at this price. I personally think it was a smart move for Tilson at that time as God knew when the share price was going to fall, and the stock still had good momentum with all good operating results, but the belief in a falling price with such rich valuations is quite firm.
As predicted, after reporting a jump in profit in the fourth quarter 2010 pushed the shares higher, CEO Reed Hasting decided to raise the rate for the price of renting one DVD at a time and for unlimited streaming from about $10 a month to about $16 per month. Then Netflix lowered the third quarter forecast by 1 million subscribers, from 25 million to 24 million. The expectation that DVD-only subscribers are down from forecast 3 million to 2.2 million, and streaming-only subscribers are from 22 million to 21.8 million. In addition, Netflix has too much difficulty obtaining more content, as the agreement with Starz, the provider of hit movies such as Toy Story 3 and several TV shows including Spartacus, has come to an end. Starz will not provide TV series and movies to Netflix after February 2012.
Now I think it is the best time to begin shorting Netflix, with the combining of two forces: One is fundamentally high valuation represented in the stock price, and second is the negative momentum happening in the stock price caused by the downward adjustment forecast in the business performance. That results from the discontinuation with one of the good hit movies and series content provider, and the restructure in the business operation along with the rising rates for DVDs. The customers have to pay more for DVDs to get less in streaming than they had before. That’s the destruction in customer service and business models.
In the longer term, it is hard to determine who’s going to be the winner in the streaming business: Hulu, ITunes, Amazon or Netflix. It is all about how the management plays out in the game with its competitors, and the cost effectiveness to obtain premium content and the value it gives to its subscribers compared with the fee they have to pay. Currently, the future is not very bright for Netflix; with the high valuation, it is definitely not a buy, but rather a stock to short.
This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.
