Netflix: Why the Truth Probably Will Not Surface Anytime Soon

Jul.18.11 | About: Netflix, Inc. (NFLX)

The Netflix (NASDAQ:NFLX) pricing controversy is one of those stories that transcends the stock market, pervading popular culture. Even some Hollywood people aren't taking it very well.

Everybody has an opinion about why Netflix raised prices. Because most of Wall Street's peanut gallery has finally spoken, can we now state what the bears have long known as fact? Netflix has problems. The problems are so big that Len Brecken's short case for the stock looks like it might be finally playing itself out. I am short the stock via put options and fully expect it to be well below $200 before the end of 2011.

I stand by my case, informed by people close to the situation, that Netflix did what it did because the move studios dictated it. In summary, Hollywood does not want the DVD to die. This shift will send more people to DVDs than most observers seem to think. By renewing its focus on the DVD business it once left for dead, Netflix can cut better deals on digital content. Down the line, when streaming equals DVD quality-wise, Netflix can split into two separate companies.

An issue I beat the drum on months back now rears its ugly head in relation to this situation. And it serves as the primary reason why (a) the whole story likely will not come out anytime soon and (b) the company can carefully craft its public face through this whole mess. It goes beyond a good PR department and it gets into a situation that should infuriate all investors.

Netflix reports earnings after the close on Monday, July 25th. The company will put out a press release and a letter to shareholders, followed by a "live" conference call. As I have explained in the past, this conference call might as well be pre-recorded.

Here's how it works: Anybody in the free world can send a question to Netflix's Investor Relations Department. The company selects questions. The Netflix VP of Investor Relations reads the questions on the call, as CEO Reed Hastings and CFO David Wells answer them.

To call that format "live" is disingenuous. Sure, technically, it's live. The game of Q&A table tennis between Netflix executives happens in real time. That said, it's something just north or south of scripted. It has to be. Do you really think the Netflix VP of IR is going to ask questions that Hastings and Wells do not expect? Will she probe? Will she toss out an unexpected follow-up? Will she press? Will she throw a change-up, curveball or Ron Guidry slider? Not if she likes her stock options.

At the very moment when investors and the public need it most, they will not receive the benefits that can come along with the conference call that accompanies a firm's earnings release. And that's because Netflix chooses to conduct the call in a fashion opposite to practically every other company in existence. No chance exists for the executives to get grilled on what could go down as one of the most ill-advised moves in the history of entertainment and corporate America.

To top it off, Netflix spokesperson Steve Swasey told me via email, prior to the big news breaking, that "Reed isn’t doing any interviews for now." Swasey noted that he would be happy to speak with me, but that has yet to come together. I'll give him a pass;. He must be absurdly busy right now.

And the kicker comes from Netflix's Q1 letter to shareholders:

Click to enlarge
Click to enlarge

At least last week's news made the reasoning behind that move quite clear. Because the subscription change does not take effect until the beginning of the last month of Q3, we're unlikely to get any real color as to the impact beyond what could be a subscriber exodus of epic proportion. There's no way a dog and pony show conference call, the CEO taking a breather from interviews or providing even less information to investors can keep that all important number out of the public eye. If Netflix ever decides to stop telling us how many total subscribers it has, we can then state, unequivocally, that the company has serious challenges.

That reality, however, was quite clear long ago despite the stock's ability to defy logic and move up on the air known as momentum.

Disclosure: I am short NFLX.

Additional disclosure: I am short NFLX via a long position in NFLX put options.