Will Netflix Disappear?

Oct.24.11 | About: Netflix, Inc. (NFLX)

Once again, I get to showcase my extremely bearish and accurate call on Netflix (NASDAQ:NFLX). [Watch my May 2011 TV interview here]

I warned investors in February and again in May that Netflix was setting up for disaster. I even followed up on September 19th and explained how I predicted Netflix’s fall and why things were only getting worse from there. If you listened, you could have made some big profits by shorting or at least saved yourself from huge financial losses by getting out or avoiding getting in.

Netflix’s troubles just keep getting worse and worse. To recap the huge red flags that should have warned investors and will continue to plague the company in the future:

  • Netflix’s valuations were extreme, signaling that any slip-up would severely damage the stock.
  • The shift from its dominant DVD business to a streaming-content business brought it face-to-face with a business model it could no longer dominate. Huge and growing competition like Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Hulu, Google (NASDAQ:GOOG), Dish Network (NASDAQ:DISH), and many other companies with deep pockets and tremendous resources meant Netflix would not be able to hold the top rank for much longer.
  • Streaming content costs have become unsustainable, and Netflix simply can’t afford its own collection of movies and shows. This has cut into Netflix’s profits and is a lead cause for Netflix’s tremendously weak content library. Netflix has attempted to hide this big weakness by pushing off costs into the future, but it can’t run away from its problems forever. Eventually, costs catch up and profitability disappears; and at that point, so does the stock price, which has been based on massive expectations by investors.
  • Netflix has lost content right and left, either by failing to renew contracts (with the likes of Starz) or by not being able to afford new content. Since its entire business is based on content, its dwindling video library is almost a sure sign of a dying business.
  • By overstating its earnings and hiding much of its liabilities off the balance sheet, Netflix may have been involved in accounting manipulation and fraud, which could bankrupt the company if surfaced.
  • Management has been increasingly shady and potentially fraudulent, with a mysterious resignation by the CFO at the end of last year as well as massive insider selling of shares by CEO Reed Hastings and other officers. The CEO has essentially been selling millions of dollars-worth of shares to the latecoming small investors who trusted in Netflix.

To make matters even worse, Netflix recently announced that it would spin off its DVD business and call it Qwikster. Not only did management fail to realize that the Qwikster name was already taken on Twitter by a drug-involved individual (huge PR mess), but it also really angered a lot of its subscribers who would now have to pay as much as double the price for both DVDs and streaming. And since Netflix’s success relies largely on subscriber growth, the disgruntled customers’ exodus may have sealed Netflix’s fate for failure.

Will Netflix Disappear?

As noted recently: “If Netflix can’t afford content and can’t maintain its library, it is doomed to fail.” I still hold that to be completely true. Moreover, with the downtrend firmly intact, I knew a Netflix comeback would be nearly impossible since “Netflix is in free-fall territory”. The stock price had plummeted, but many investors still refused to accept the reality that Netflix is in a downward spiral and could be on its way to bankruptcy, or at least on its way to becoming irrelevant. The momentum is very strong on the way down, just as it was on the way up. With competition continuously rising, strengthening, and eating away at Netflix’s once-dominant business, I expect Netflix’s troubles to continue from here. Competition has finally broken Netflix.

The huge mistakes made by Netflix’s management, the increasing and unsustainable costs, the dwindling content library, the failed expectations by investors, the mass subscriber losses, the potential for surfacing accounting manipulation, and the tremendous downward momentum that has taken Netflix from over $300 a share to under $90 a share in less than four months are all reasons Netflix could quickly fade from here. The stock may have fallen back to earth, but the company may still get buried deep under ground.

Disclosure: I am short NFLX.

Additional disclosure: Chart Prophet Capital is short NFLX through Put Options