Netflix: A Tale Of Greed And Lack Of Foresight

| About: Netflix, Inc. (NFLX)

Netflix (NASDAQ:NFLX) is a great service. They've changed the way people watch movies and TV shows. However, as a company, they've made poor decisions in the past couple years and it will soon have a significant impact on their customers.

Netflix's Content

Netflix's key value is putting quality content at the fingertips of their customers. Without doing that, they're dead in the water.

As a result, maintaining their key content deals is vital to their future. Since many of these deals are due to expire in the next year or two, management should have made sure they were in a strong financial position to re-negotiate these deals.

The original deals struck by Reed Hastings and his team were great. They paid minimal amounts per subscriber for quality content and enjoyed good margins. However, with Netflix's success, content providers noticed this. As these deals have come up for re-negotiation, content providers have been seeking substantial increases in the amount Netflix should pay. For example, one of their content providers, Starz, was seeking an increase of 10 times on their original deal of $30 million / year (source).

There are major increases in content costs on the horizon and the Netflix management team should have prepared for this. Their booming stock was a great opportunity to better position themselves for the future.

52-Week Highs and Stock Buybacks

In June 2010, Netflix shares were flying. The price had increased by 120% in 6 months.

At that point, they should have been taking advantage of their high stock price by issuing shares. This would have helped them establish a strong financial position to deal with increased content costs in the future.

Instead, they made an extremely poor decision. In June 2010, Netflix announced a $300 million share buyback. Stock buybacks generally indicate that management believes shares are undervalued. At $120/share, they weren't undervalued. A fair value would have been around $60, tops.

It seems like the main reason for doing these share buybacks was to drive the stock price higher. Looking at insider transactions, management benefited greatly.

However, this was a grave error for Netflix as a company. This money should have been allocated towards content and delivering a great customer experience. It was wasted on stock buybacks.

In 2010 and 2011, Netflix spent over $400 million on stock buybacks. It's no coincidence that they are now recapitalizing themselves for that exact amount. The big problem is they bought back shares for an average price of ~$186 and now they're reissuing them at around $70-80. It's pretty clear they made a mistake to allocate this capital towards boosting their stock price. They should have known they would need it in upcoming years to maintain their content library.

Where They are Now

It's clear that management has been making poor decisions and can't be trusted to do what's best for the company. This makes Netflix a very risky investment.

As a Netflix subscriber, I genuinely hope they start to turn things around. However, as an investor, management's lack of focus and the potential for their margins to be squeezed keep me away.

On top of that, their stock price is still higher than NFLX's intrinsic value.

Even after shedding over 70% of its value, Netflix is still not a good buy.

But, as a customer, I do hope they pull things together and refocus their business on what's important - making us customers happy!

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

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