About 400 pages into Haruki Murakami's 1Q84, I took a break to check out the latest Netflix (NFLX) headlines. After reading Tiernan Ray's Saturday article in Barron's, I decided that, like Aomame, the main character in Murakami's already epic tome, I must be living my own reality separate from NFLX bulls. Let's call the world I'm living in 2Q11; the unreal world they inhabit 2011.
Before I discuss Ray's article, have a look at its title - Down 79% From Their July High, Netflix Shares May Be A Buy - followed by a summary of other pieces that came before it.
- Just last week, on November 23rd, Fortune proclaimed NFLX "down, but not out," noting "At $70.45, it sits at just 23% of its 52-week high of $304.79. Have the company's prospects really fallen by 77%? Not even close."
- On September 21st, citing the "growth" argument, a Motley Fool writer advocated buying shares of Netflix "If (or when) the stock drops further ..." Sadly, the author did not provide his readers with an entry price somewhere between the high-$120s and low-$60s.
- Dateline, August 25th, Piper analyst Michael Olson reiterated his "overweight" rating and $330 price target on NFLX.
- Back on August 18th, Trefis, for some reason, suggested NFLX "as a defensive play" while setting a $221 price target.
- On July 30th, with the stock trading around $265, another writer for the Fool noted that NFLX "exhibits some of the characteristics of a quintessential Buffett investment." I did not know Buffett is a famed short-seller.
But, back to Barron's. In mid-September, the well-respected publication conceded that "our timing on this stock has clearly been off, (but) we remain bullish and think Netflix shares could rise again." Touting that "Netflix Shares Can Overcome Hurdle," Barron's noted:
The new pricing strategy that the company announced earlier this summer was expected to have some effect on subscription rates, but the fact that Netflix did not change its financial guidance suggests that the higher prices may be at least partially making up for the lost customers.
Shares trade at 33 times forward earnings - not unreasonable, considering earnings are expected to grow 57% in 2011 and 48% in 2012.
Talk about a poorly-researched and short-sighted view. Literally everything in those two paragraphs has turned out objectively false.
I call out this sampling of the inanity, in part, to issue a warning to traders and investors looking to get into NFLX. I commit an act of mercy when I refer to the work these analysts and authors have put out as "poorly-researched and short-sighted." It's so much worse than that. Consider the above-mentioned and most recent egregious example of sloppy coattail riding by Barron's Ray from over the weekend.
Ray's thesis (which is really Whitney Tilson's thesis) effectively amounts to the related hybrid of things can't get much worse and it's really tough to imagine the stock price going any lower. This is the same tripe we heard from Research in Motion (RIMM) bulls ahead of the stock dropping below book value.
Ray does an excellent job summarizing Netflix's recent problems. But then he promptly ignores them, leaving readers with Tilson's contention that "even though they'll lose money the next couple of quarters, people will be surprised at how resilient the subscriber base turns out to be" and Whitney's somewhat hesitant prediction that the stock will double.
Ironically, while I do not advocate ignoring Netflix's near-term stumbles (the price increase, Qwikster and the $400M cash grab), I think investors do themselves a disservice by focusing, almost solely, on them.
Ray - and Barron's, the publication he scribes for - treats the missteps as the core problems eating away at Netflix's stock price. In the process, he, like many other Netflix bulls and apparent "bargain" hunters, makes little, if any, mention of the storm that brewed before these seemingly ill-advised errors.
By ignoring the reality that a handful of authors, primarily at Seeking Alpha, and several analysts hammered home this past spring, Barron's, Ray and other bulls fail to see that the price increase, Qwikster still birth and $400 million financing ruse are little more than symptoms that should help any investor make the diagnosis that Netflix is dying a not-so-slow death. Simply put, these moves that Reed Hastings made represent nothing more than desperate reactions to a broken business model.
It's time to forget how far NFLX has fallen and get back to basics. Go back and read the articles I wrote in April and June.
April 5th - Netflix's Business Model Isn't Sustainable
June 19th - Is It Finally The End Of The Road For Netflix?
From both quantitative (i.e., a look at the financials) and qualitative (i.e., the competitive landscape) standpoints, those articles - as well as the dozens of others I wrote about the stock - contain actual research. Not a hope and a prayer and flimsy and vague assertions. It shocks me not only that Barron's, Tilson and others ignore that work and the work of people like Len Brecken, Michael Pachter, Tony Wible and plenty of Seeking Alpha authors, but that investors actually pay money for advice from Barron's and Tilson.
This is not to say that either entity is without worth. Both, of course, have longer and stronger track records than I do. That said, their approach to Netflix ought to signal some serious red flags. And this is exactly where I feel like I live a different reality than outlets like Barron's and money managers like Tilson.
All I can really do is state the lunacy of the bull case plainly. After effectively downplaying or flat-out dismissing the warnings I and others put out in spring and early summer, the bulls focus on Netflix CEO Reed Hastings' well-publicized blunders. This, of course, plays right into Hastings' hands, as I explained earlier this month:
First of all, I cannot stress this enough - forget about the price increase and the Qwikster still birth. Netflix CEO Reed Hastings wants investors - and consumers - to focus on these two things to ensure that they take their eye off of his company's endemic structural problems or never recognize them in the first place.
He can easily spin these two moves as temporary pain, however, he cannot distort the reality that Netflix is attempting to execute a business model that simply will not work.
From there, the remaining bulls commit the unthinkable sin. Not only do they cast off the most dire warning sign of all - a desperate cash grab with absolutely horrible terms - but they exhibit a stubborn refusal to learn from history.
Here's a company that literally changed directions on a bi-weekly basis for a considerable period of time after telling everybody, on pseudo-conference call after pseudo-conference call, how healthy their business was. And then, after Hasting's "virtuous cycle" was proven a sham and off-balance sheet expenses continued to grow by the billions, the bulls chose to conveniently ignore or buy - hook, line and sinker (I'm not sure which is worse) - the company's comical explanation for its pair of $200 million financing moves:
Netflix spokesman Steve Swasey told The Wall Street Journal on Monday that the company doesn't have a pressing need for more cash, "but it's always nice to have more money than you need." He said the company has no immediate plans to use the funds. He added that subscriber cancellations have continued to decline, meaning that Netflix could soon see its subscriber base grow.
If you choose to continue to fall for Netflix's games, you deserve what you get. For the same reason that Google (GOOG), Apple (AAPL) or any other sane and prudent company will not buy Netflix the company, you should not buy NFLX the stock. At least not with money you prefer not to lose.
NFLX was not a buy on anything other than momentum before the bottom fell out. All the price increase, Qwikster and the laughable capital-raising scheme have done is expose Netflix's never-sustainable business model. Simple math shows there never was a way subscriber growth could fuel content acquisition or international expansion, let alone both simultaneously.
With all logical signs pointing to a RIMM-like collapse for NFLX, it truly feels like an absurd version of reality to see defenses such as the one put forth by Credit Suisse in the above-linked WSJ article:
However, we are positive on the capital infusion, as it strengthens NFLX's balance sheet and improves its financial flexibility.
This is akin to lauding a family for financing a two-room addition and side trip to Vegas with credit card cash advances. I know I've said it before, but, at this juncture, there's truly nothing left to say. If you cannot clearly read the writing on the wall after everything that's happened, you deserve to lose your money and average this dog down as it craters to below book value. Or, as Murakami stated so well:
If you can't understand it without an explanation, you can't understand it with an explanation.