It's been a tough and volatile road to be short Netflix (NASDAQ:NFLX), as we have been since 1Q 2011. Our thesis then was that Netflix was getting into what we considered "the perfect storm." Not only did the company trade at obscene valuation multiples but it had to deal with (i) prohibitive increases in the cost of future content, (ii) broadband providers in the US getting increasingly irritated with the fact that 20% of US night-time traffic was Netflix related and was causing a number of issues and slowing down networks, and more importantly (iii) the emergence of powerful competitors into the arena of streaming video [such as Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN), which each alone has more cash in their balance sheets than the total market capitalization of Netflix].
To add insult to injury insider sales of Netflix were at a pace that we had rarely seen (usually not a good sign when top execs sell at this pace).
The problem of Netflix is that it "invented" a great product (without a doubt) but in an arena where there are absolutely ZERO barriers to entry. The US being the brilliant capitalistic society that it is, it was only a matter of time until better capitalised competitors would appear to get a slice of the action (and until the sellers of content realised that they had severely underpriced their first deals, which would force NFLX to raise prices), both of which would have severe negative impact on NFLX's potential profits.
The last remaining bad news that we are expecting is a very disappointing international expansion. Netflix has no brand awareness whatsoever outside of the US & Canada. It will have to spend huge amounts of capital to penetrate new markets. And that will not be easy to do as it generates very little cash flow and would have either to issue equity or raise debt in order to go into a risky international expansion. That will be the last shoe to drop in our opinion.
This summer probably marked the beginning of the long road for Netflix to reach its fair value, which is something in the region of $60 to $80 a share (assuming it doesn't insist too hard on the international expansion).Disclosure: I am short NFLX.