Netflix Continues To Distort Reality For Investors

Oct.11.11 | About: Netflix, Inc. (NFLX)

I spent a fair bit of time Monday morning walking near the Pacific Ocean in Santa Monica, stopping from time to time to read a book of short stories by Haruki Murakami. I'm fired up because later this month, Knopf releases the English version of Murakami's long-awaited 1Q84. The book, like most of what Murakami writes, deals with, to put it simply, the concepts of reality and chaos.

In the above-linked New York Times piece, Murakami wrote:

Let’s call the world we actually have now Reality A and the world that we might have had if 9/11 had never happened Reality B. Then we can’t help but notice that the world of Reality B appears to be realer and more rational than the world of Reality A. To put it in different terms, we are living a world that has an even lower level of reality than the unreal world. What can we possibly call this if not “chaos”?

I considered the concept of reality, and my perceptions of it, as I digested not only Netflix's (NASDAQ:NFLX) latest brush with schizophrenia, but investor and consumer reaction to the company and its CEO.

Speaking of things that seem surreal - the late founder and former CEO of Apple (NASDAQ:AAPL), Steve Jobs, must be rolling in his grave watching the continued display of ineptness by Netflix CEO Reed Hastings. Hastings picked a horrible time to make yet another errant move.

As the more-than-deserved tributes to Jobs pour in, Hastings provides the excellent counter-case study. Of course, to truly know what's really good, you've got to have examples of what's really bad - and vice versa. While Jobs made strategic and marketing decisions at Apple with an almost flawless sort of grace, Hastings' recent performance makes you wonder if what you think you see happening is actually happening.

Up until now, Netflix received a pass from most people. While a handful of us pointed out, repeatedly, what a sham the whole business is, Hastings proceeded to make the crowd believe he knew the score. Somehow, he built this reputation as "a CEO with a pretty firm grip on things." Thinking that he was ever so shrewd reflects either blatant ignorance or a refusal to see the obvious - the strategy of committing to billions of dollars worth of licensing and international expansion expenses in the face of the inevitability that subscriber growth would slow, stall or reverse never had a future.

Investors, particularly at the retail level, bought it, I believe, because we are living a world that has an even lower level of reality than the unreal world. Given what we saw happen on 9/11 - and the myriad flavors of noise we consume, from every angle, everyday - we let injustice, absurdity and other low- and high-level atrocities pass under our collective noses without even realizing that they're there. Simply put, our societal bar for B.S. is so low that option-exercising CEOs can sell snake oil - and receive unanimous praise while doing so - until their behavior becomes so pathetically foolish, misguided and erratic that even a community as desensitized as ours can no longer ignore it.

Here's what I wrote back in early April:

As it stands, the Netflix business model of impressive growth combined with mind-boggling expenses that will only go up is simply not sustainable. Sooner rather than later, Netflix will run into a cash flow problem. Netflix has short written all over it. Two years from now, I think we will be talking about one of two things: a sub-$100 NFLX share price or Netflix Streaming by (take your pick of) Apple, Google (NASDAQ:GOOG), Verizon (NYSE:VZ), or AT&T (NYSE:T).

Fast forward to today. And, if you buy this stock for more than a day trade, please pardon my blunt choice of words, but there's no other way to say it - you are an idiot. For what it's worth, so am I. There's no chance of a buyout, unless Hastings can sucker somebody into buying the DVD unit. And two years to sub-$100? What a horrible call.

Even with the jig up, Hastings continues to try to pull the wool over people's eyes. Consider this nugget from The Wall Street Journal article on the development:

"We underestimated the importance of the integration of the two services," said Netflix spokesman Steve Swasey. He added that the DVD division, which would have no interaction with the streaming business, would move to new offices in nearby San Jose, but that customers wouldn't see any difference (emphasis added).

In other words, from a business perspective, nothing has changed.

Just because consumers and investors have difficulty making sense of the unreal world does not render them stupid. The decision to shutter "Qwikster" before it started is nothing but window dressing. It's a last ditch effort to salvage the business, from a consumer perspective, before Hastings has to answer the call on the prediction that Netflix would post a $1 billion fourth quarter. For all intents and purposes, Q3 is shot - and probably in a much worse way than even Hastings conceded back on the Q2 call. Once Q4 implodes, a $100 stock price for NFLX might represent a double.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in NFLX over the next 72 hours.