Netflix: What Gives Investors a Reason to Believe?

| About: Netflix, Inc. (NFLX)

Sometimes I mistake services like for The Onion when headlines and notes like these, which hit this morning, come across my feed:

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Presumably the Goldman Sachs upgrade played a key role in helping Netflix (NASDAQ:NFLX) hit an all-time high of $301.50 this morning. It struck me kinda funny, kinda funny sir to me that news of the company launching a new DVD plan did nothing to cancel out the impact of the upgrade:

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To use the term "slight departure" waxes just a bit too euphemistically for me. But no matter what the news is, at the end of every hard-earned day, Netflix analysts and investors find some reason to believe. Reality does not play a role in what this stock does.

From here on out, I will do my best to refrain from interjecting opinion into the proceedings. I just want to lay out some facts and ask why in the world do investors ignore these realities and continue to drive NFLX higher?

First, from Netflx's last conference call, which took place in late April:

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I guess the key words in Hastings' answer are "at this point." I just did not realize that the company would do an about-face in the span of about a quarter. As the storyline went, Netflix would use the money saved by de-emphasizing DVD delivery to buy up streaming content.

Here are two snippets from the company's Q1 letter to shareholders:

In January, we spoke of redirecting the savings generated from a flattening DVD shipment trend into additional streaming content and marketing ...

We believe that DVD will be a fading differentiator given the explosive growth of streaming, and that in order to prosper in streaming we must concentrate on having the best possible streaming service. As a result, we are beginning to treat them separately in many ways. Already, if you look at our sign-up page for non-members, it is all about streaming. Having said this, DVD rental is still a great business for us, and we are working on solutions to make sure DVD continues to be a profitable business for us in the years ahead, but it is not core to winning in streaming at this point.

Big questions come up for me as I review this material. It appears that Hastings and Netflix have spoken out of both sides of their proverbial mouths on the issue. On one hand, there's talk about DVD as "fading" and "redirecting savings generated from" decreased DVD shipments elsewhere, namely streaming. But, to be fair, the company never quite closed the door on the DVD business. Like many things Netflix, it's all imprecise.

We can now look back on what Netflix CFO David Wells said about a "renewed focus" on DVDs as foreshadowing to this $7.99 unlimited deal. Here's the issue - and this stands at the forefront as a solid example of the types of things NFLX believers appear to ignore - when comparing the two: The costs associated with DVD are variable, while revenues are fixed. In other words, NFLX will generate $8 in revenue from one unlimited DVD subscriber, but there's no telling how much that subscriber will cost to service.

What does that do to the notion of spending DVD delivery savings on content? How can the company feel confident putting billions toward content with, presumably, less cost savings, if any, coming from the DVD segment going forward? I find it hard to believe that the strategy of de-emphasizing DVDs was intended to be as short-lived as it turned out to be. And what does it mean going forward in terms of Netflix's ability to pay for content?

This leads directly to other issues it appears NFLX bulls continue to ignore. In a CNN/Money story that went under the radar this morning, Wedbush's Michael Pachter brought up the exponential increase in Netflix's streaming content costs, which he sees going from "$180 million in 2010 to a whopping $1.98 billion in 2012."

The story also reminded us that the apparent "temporary" removal of Sony movies from Netflix's streaming service turns out to be not so "temporary" after all. In fact, it might have real and looming implications as programmers begin to turn the screws on Netflix. They'll continue to command a higher premium for content, at the same time as Hulu is on the block with cash-rich Netflix competitors Google (NASDAQ:GOOG), (NASDAQ:AMZN) and DISH Network (NASDAQ:DISH) all vying for more than a simple piece of the pie.

I thought investors were a skeptical and skittish bunch. I thought they did not like imprecision and uncertainty. If it's all about riding momentum, I get that. But based on the defenses I see people make on Netflix's behalf, it seems to me that the longs actually believe in this company. I ask then, how does a NFLX bull look past such a seemingly inexact and, dare I say, fickle business strategy?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.