Whitney Tilson's pronouncements on Netflix (NFLX) have been a fairly accurate contrarian indicator over the past few years. Notoriously, he presented his short thesis on Seeking Alpha while shares were $178 and climbing in late 2010; that thesis was attacked by Netflix's CEO, Reed Hastings, on Seeking Alpha shortly thereafter; and Tilson threw in the towel via another Seeking Alpha article in February 2011.
Shares continued to rip through mid-2011, as Tilson and clients were probably heaving sighs of relief that he unwound his trade. However, as is the case with most stocks with triple-digit P/Es and unrealistic expectations, the bottom then fell out (after Tilson had closed out his short). (Chart: Yahoo Finance)
Shares fell by about 75% in less than six months before bottoming in late 2011. A temporary recovery in 2012 was followed by shares hitting their lowest lows near $50 in mid-2012, before beginning one of the steepest rallies I've ever seen. Massive short interest coupled with a Q4 12 earnings beat resulted in a near doubling of shares in just a few sessions in early 2013. Another good quarter (at least in the eyes of bulls) added another $50 to the share price in April. Shares now trade over $200, a level not seen since September 2011.
Back to Tilson. In an interview on May 13th, Tilson divulged that he loaded up on Netflix shares after the big decline and still sees room for shares to run. His main rationale for continued price appreciation (at least based on what was discussed in the interview) was a throwback to the dotcom era -- he said that Netflix was too cheap based on the value of its subscribers.
Tilson noted that the market currently values Netflix subscribers at approximately $400 each -- which is way too cheap, apparently, because other companies (cell phone carriers were mentioned) are valued at about $1000 per subscriber. Apparently, according to Tilson, all subscribers are created equal -- but that is absolutely not the case in the real world.
In Q1 13 (which was a quarter that Wall Street applauded), Netflix had about 28 million paid domestic streaming suppliers. (This is the best benchmark to use for this analysis, as Netflix is winding down its legacy mailed business and its international business is currently unprofitable). Those 28 million subscribers generated $131 million in "contribution profit" (which excludes marketing costs). That means that each subscriber generated a little less than $5 of contribution profit during the quarter, or is expected to generate about $19 on an annualized basis.
Tilson must think that Netflix subscribers are very, very sticky, because at $19 per year (of contribution profit, which doesn't even include marketing and G&A costs), a customer will have to stick around for over 21 years to generate the $400 that the market is currently valuing him at. Even if Netflix is somehow able to increase contribution margin on its streaming subscribers to 50% (which seems unlikely, given that content producers will squeeze Netflix for all they can), it would still take 10 years for an $8 subscriber to generate $400 in contribution margin for Netflix. The valuation simply doesn't make sense.
Another check against the unjustifiable $400/sub valuation comes from looking at comparable companies. Blackberry (BBRY) still has a subscriber base of almost 80 million customers, who generate recurring fees (at a much higher profit margin for BlackBerry than Netflix subs earn for Netflix). At BlackBerry's $8.3 billion market cap, the market says that BlackBerry's higher-margin subscribers are worth only about $100 each -- which, if applied to Netflix, would equate to 75% decline in shares (close to the $50 low seen during 2011). And Tilson's comparison to cell phone service providers doesn't hold water either -- a $1,000/customer valuation makes a lot more sense when a subscriber often generates $1,000 per year in (again, higher-margin) revenue; plus, cell phone companies generate a lot more cash than Netflix, as evidenced by Verizon Wireless's forthcoming $7 billion dividend to its parents.
Despite the absurdity of Tilson's argument and the likelihood that Netflix shares eventually return to earth, I do not think that it is time to short Netflix yet. Later this month, Netflix has a major positive catalyst in the release of new "Arrested Development" episodes, which will likely juice subscriber numbers for the second quarter. I think that Netflix will likely beat expectations for subscribers (and potentially revenue/profit, if new people signing up around May 26th for 'Arrested" stay for a second month), and Hastings will also be able to spin the story of a one-time boost in results from the return of a cult classic into a validation of the overall content-creation story. I'd expect shares to rise into and after Q2 results.
However, the market is ultimately a weighing machine, and shares can't go up forever if Netflix remains as marginally profitable (and cash-flow negative) as it is today. Eventually, there will be a catalyst that reverses all momentum. As that catalyst is not yet clear (and there appears to be at least one positive catalyst on the horizon), it's best for bears to avoid Netflix completely for the time being.
Also, for what it's worth, the lead time on the Tilson indicator in 2011 was about 6 months; as such, it seems prudent to wait patiently for the time being and reassess the merits and timing of a Netflix short later this year.