Contributor since: 2011
I sold them a long time ago for a 300%+ gain, thanks for checking back. This thing was obviously ready to rocket up once it exploded out of the $60 range, I haven't been short NFLX in quite a while.
"The allegations about accounting irregularities come form a convicted felon who has very little credibility where I sit. Auditors and the SEC get really sensitive these days and these guys have a professional board and a strong audit committee."
First off, the SEC wanted to see restatements. Then, David Einhorn, one of the most thorough and accomplished short selllers out there who does more research and more accounting analysis on his shorts than just about anyone, elevated the attention. If you doubt Einhorn's level of research, go read his book about his short on Allied Capital. So saying the accounting argument lacks credibility is questionable at best, in my opinion at least.
Personally I think this is $3 stock in a couple years, but that's what makes a market. GL to all, long or short.
That was my reading of it as well, thanks for the insight alibabba.
Getting back to the point, why would Starbucks buy GMCR and inherit all their accounting problems, when they can just license the VUE k-cups that do still have patent protection? Or they can continue to license the existing ones if they want to. How does that make a takevoer sensible? Being a licensee, Starbucks can continue to make money w/out the headache of taking over a company with a lot of assets, infrastructure, and accounting problems that they don't need.
Yes, and they are only doing that through GMCR because thats their only option until patent expiration. Furthermore, that equals margin erosion for GMCR, since they make less on a Starbucks k-cup than they do on their own.
Once that patent is over, why would starbucks renew a licensing agreement instead of doing it themselves?
I don't really think you can fairly cite yoy sales growth when GMCR has had a monopoly until now. Starting in September 2012 with the k-cup patent expiration, its nearly guaranteed that the sales growth will fall as cheap competition starts to flood this market. On top of that, shrugging off accounting irregularities is a huge gamble at best, especially if you've read and understand Einhorn's short thesis, that that accounting problems are endemic in this company.
Also, you don't really explain why a Starbucks takeout "makes a lot of sense." I think it makes very little sense. Without intellectual property protection, its hard to see where the value is with GMCR. Starbucks is already gearing up to sell their own single-serve machine, all they have to do next is take their coffee and put it in a little plastic cup and sell 12 packs of it in their tens of thousands of stores, as well as supermarkets, etc.
Nice article. In addition to the challenging picture right now, and that both retail and food stocks alike are getting hit on earnings right now, the chart setup is not good here, major trendlines having broken recently.
After seeing both retail and the food companies get hit this earnings season, its hard to see how WFM doesn't compress. Combine that with what looks like a very bearish chart setup with a couple closes below long-run trendlines, and I think its set for a potentially big fall.
The problem, in my opinion, of talking about a takeover of GMCR based on the valuation, is that no one trusts their numbers, so no one knows what the valuation really is. Their accounting problems haven't been resolved and any buyer could be inheriting legal problems from plenty of different parties. Its like RIMM, people have been screaming that its been undervalued since $20, when the PE was about 4.5. Well the stock is now a 6-handle and the PE is higher than that, there's no reason that can't happen with GMCR, which can either get crushed from slipping sales or from disastrous accounting problems.
Also, Starbucks and Dunkin already have massive distribution networks, what do they need GMCR's for? Them, and countless other big-time coffee brands can manufacture their own k-cups and channel them through their existing network. Unless I'm missing something there, which is always possible, I just don't understand what the value in GMCR would be.
You blame the GMCR fall from $48 to $25 on Einhorn's short thesis. However, this drop happened on 5/16/2012. Einhorn laid out his thesis last October, when GMCR was at $88/share. The drop from $49 to $25 happened on last quarter's disastrous earnings report.
I also truly don't understand how anyone who's read that thesis would want to be long GMCR, even at $17.
In addition to David's arguments, the chart setup for LULU right here is awesome. Its bouncing off of long-run support and there's a gap that should fill above @ $70, for a $12 gain minimum.
LetstParty - I don't know if you are aware of the following 2 issues or not, but you should be, because it sounds like you are long this thing for more than a short-term trade:
1 - The off-balance sheet content obligations. Page 13 of the last quarterly report:
These are the obligations for the streaming content deals, totaling $3.64 billion. That exceeds not only total liabilities, but it also exceeds total liabilities + stockholders equity. This is a very big deal, and its a big part of the bear thesis on this company.
2. The cash flow statement. Do some research and when and why Netflix added this line to the cash flow statement: Change in streaming content liabilities (page 6, cash flow statement). This number was not there a year ago, and notice that it is solely responsible for the bottom line of the cash flow statement being positive. Change in streaming content liabilities = $397 million. Total cash and cash equivalents (bottom line) = $395 million. Much has been written on Seeking Alpha about this entry, I'd recommend reading about it, because its extremely questionable whether or not this is a cash related item, and it has a dramatic impact on the cash flow statement.
Frank - The reason you see the assets growing is because Netflix counts the streaming content licensing agreements as assets. So when they spend a billion on a new deal, they add some of that to current assets and the rest to intangible assets.
Of course, calling these things assets is pretty generous. They are indeed intangible, and its not like they can sell a licensing agreement. Really they are just expenses necessary for operation of the streaming unit.
The very simple long-run problem netflix has is that the cost of content is constantly rising and will continue to do so, but they have run out of people in the US (international markets are a very long way from profitability) to sell to, so they have exhausted their growth. Its not a sustainable situation.
As far as shorting goes, I don't like the technical setup for a short right here. There's a big gap in the chart from last quarter's earnings, gaps in charts are filled 90% of the time, and in this case that would take netflix back to $100. $100 is also the 61.8 fibonacci retracement of the $125 to $62 fall between April and June. For those unfamiliar, that's a very typical retracement and reversal point. So technically, its very probable it gets to $100 in the near future, it could be a runup into earnings, or it might take the earnings report to get it there. I'll be shorting aggressively at $100, and not until then or very close to it.
What about the fact that Starbucks is going to make their own k-cup machine? Once the patent is up, there will be plenty of k-cup machine manufacturers. And besides, GMCR doesn't make any money on the machines anyway.
I think price is the ultimate issue here. Generic k-cups are going to cost 20 cents a year from now, and no one is going to pay 50 cents like they are paying now. Where's the moat? How does GMCR avoid a price war with Kroger, Wal-Mart, and Costco? And that's ignoring the accounting irregularities.
Ben - Nice article.
GMCR Bulls - If someone doesn't mind critiquing the following argument, I'd appreciate it, because I simply cannot understand the bull thesis on this:
This company makes most of its money on the k-cups, it makes very little on the machines (the gillette model). However, with the only significant advantage its ever had, the IP protection on the k-cup expiring, what is going to keep this company in business? The GMCR k-cups, at fifty cents per, are obscenely expensive for what they are, and once that patent is gone, the floodgates of competitors will come in. Furthermore, Starbucks has announced their own k-cup machine coming, so expect plenty of hardware competition as well.
So how exactly is GMCR going to survive the onslaught of cheap competitors that is coming later this year? They will have zero moat in a commodity business against much bigger competitors.
Haha you can't hang it up now after that Vanity Fair article. Although in all seriousness, I completely understand the sentiment here. I've written a miniscule amount about NFLX compared to you, and even I feel like there's not much else to be said about it. Everything the NFLX bears have said would happen is happening and will continue to happen. All the financials are getting worse, the death spiral is still in effect, and its a matter of time before they'll have to raise more capital. The story is going to keep playing itself out, and you don't really want to be constantly writing articles that quote yourself from 9 months ago and say "here, check this out, I was right, thank you very much!" So unless something truly unprecedented or unpredictable happens, I completely understand shutting it down, at least for a while. Let the thesis play out as it inevitably will, and I'll be checking in on your other articles.
A quick personal note, your NFLX articles taught me a lot about how to evaluate a company fundamentally and the importance of understanding the business model at a core level. I also made some solid money as a result, but the knowledge is the real key here, so just want to say thanks. I've also enjoyed discussing NFLX with you the last several months and getting to know you a little bit. As always, I'll be looking forward to your future SA articles, w/e the topic may be.
J - A very well reasoned article, really enjoyed it and the clarity of the financial disaster that netflix has put itself in (also thanks for the plug :). I do agree they will most likely figure i how to avoid bankruptcy with more capital raising (as you mentioned, my bk thesis does not include more stock offerings). You also nailed it that no one will buy them, its important for everyone to remember that the content licensing agreements do NOT include provisions to be modified or voided in the event of a sale of the company or bankruptcy. So any acquirer would be stuck with those very steep obligations.
On the ipad sorry if this was sloppy.
What about the technicals looks so good to you right now? I see pretty good resistance @ $105 (also a fib number of the $120 high to the $63 low) that was just tested and failed, a narrowing MACD histogram, negative RSI divergence after being above 70, overbought stochastics. This is all daily chart btw.
Thanks for the plug buddy, a great summary of the current situation. I think we'll see a drop on earnings, and I do think this is a tremendous short opportunity for those not in or who have the room to add. The facts are so much worse than they were a year ago its not even funny.
As far as the price action has been lately, I was definitely wrong about how long this rally would last, but let's not forget that the gap-down from last earnings has now been filled. Other technical indicators are suggesting the momo slowing on this run with a turnaround possibly starting. In other words, its teed up nicely for an earnings drop. Could it go to $120 on earnings? Sure, maybe. Although if google can get wacked for 10% on a slight disappointment (thats a subjective analysis btw), what happens when Netflix re-iterates its losses for 2012?
I still think that the fund-raising never impacted the stock the way it should have. It was pure desperation and they clearly had no idea they were going to need the money 3 months prior when they were buying back stock for $220/share. That was an extremely telling event that got some noise, but the shares never really reflected that level of bad news. We'll see if that starts to change.
I also don't think most investors/traders/anal... really understand that Netflix is expecting fiscal year losses for 2012. I rarely even gets mentioned and you still see plenty of analysts with positive 2012 EPS estimates. Those that do, blame the losses on international expansion, when the problem is really that they are drowning in debt due to content costs.
Lastly, throw in the one variable that no one knows yet, how much did Netflix spend on Marketing in Q4? Whatever it was, it was massive, with TV ads, facebook adds, daily emails, etc. The marketing director just "resigned," I can't help but woonder if she overspent and Netflix is making moves ahead of the call so they can point and say "she's gone, next scripted question?"
DG - Another good comment, you're one of the best informed Netflix bulls out there, and actually capable of a good argument w/out just saying "Streaming is the future, so Netflix is the future." I'm also glad to see we share an appreciation for Jeff Bridges and the Coen Brothers.
I do offer a few counter points. First, yes its true the assets are increasing with the liabilities, but look at what those assets are. They are streaming content licensing deals. Not only will these assets be worth zero in a couple years when the contract expires, but they aren't worth anything in a sale either. Anyone can go get these deals, Netflix doesn't pay a discount for them. So we can't count these toward the book value of the company, they are really an expense. The liabilities on the other hand, have to paid.
Second, let's say that the price increase did happen on July 1 to capture the entire 3rd quarter instead of 1/3 of it. Would it be fair to say that revenues would have grown 12% instead of 4%? The problem is to keep up with growing liabilities, revenue would have needed to grow by 22%, so its still a big short fall.
Third, I don't agree that Netflix is choosing growth over EPS. Unlike Google, that is not what has happened here. The international expansion is a relatively small expense for Netflix, its the billions in content costs and the fact that the content costs are rapidly ballooning that has caused Netflix to project a loss for 2012. They already grew, they've had roughly 25-30% of total broadband capable US households for a couple years now, and thats w/out measuring churn. Taking a bath on EPS is not a choice for Netflix.
Lastly, management's mis-use of cash has and will continue to punish shareholders. Netflix has spent 95% of its Net Income buying back stock over the last year. Yet the float has barely decreased because of the massive insider selling and options awards. The latest round of buybacks averaged $218 a share, and only 3 months later they sold $200 million worth of stock at $75. Thats an appalling destruction of shareholder value. It also strongly suggests that these guys can't see 3 months down the road, not exactly what you want to see in a multi-billion dollar company. Thats why I bring this up, I have zero confidence that Netflix management has control of situation when you see things like this happening.
dg - Of course I'm not calling you a liar, I just disagree thats all. Its refreshing to get a well thought out bull market on nflx, usually its just "I like the product, so the stock is a buy." Having said that, I've also done my research :)
My issue with those numbers is that the price increase did not go into effect until September 1, 2/3 of the way through the 3rd quarter, so you can's use those calculations. I don't think we can get to the conclusion that revenue per customer is rising with that in mind.
But I'm not even sure how much that matters. If you look at the Q2 and Q3 income statement, revenue only grew 4% from Q2 to Q3. Compare that to the 22% growth in total liabilities from Q2 to Q3, and the 40% growth in off-balance sheet liabilities. The financials are getting worse every quarter, and considering they had to raise capital in Q3, my guess is that Q4 will be worse still.
"But the amount paid per subscriber increased (due to changes in subscription costs)."
I'm afraid that just isn't true. We have to look at at the membership split. Most of the Netflix members before the price increase were paying $10 a month for DVDs and Streaming. Now, there is a significant minority subscribing to the combo plan and paying $16/month. Netflix has said that only 7% of new signups opt for that plan, and that the majority downgraded to either DVDs only or streaming only. So that means that instead of paying $10 a month, all these people are now paying $8 a month. In other words, average revenue per customer has fallen, we'll know how much if they report the membership numbers in Q4, which unfortunately they very well might not do since they've only sporadically done this in the past.
I'm in :) I think 10-20% is a no brainer, I'd put the over/under @ at 22-25% drop.
I really don't undrstand how you can say the streaing product is breakeven, and cite positive EPS estimates when Netflix has said repeatedly that they will lose money for all of 2012. Furthermore, where would the money come from for a redbox acquisition, issuing more stock?
DVL my problem with you is not that you are disagreeing, I love intelligent debate that challenges my thinking. Its that you're only now going around on all the NFLX short articles telling everyone how they deserved to get their heads ripped off in this rally that they should have seen coming. People have been saying the same exact thing since $150, and this 40% move is the first and only significant rally this stock has had since $300. RIMM also had a 50% move from $22 to $32 back in August/September, and look where it is. These are fundmanetal stories, companies with crumbling foundations and they are rapidlly losing money in Netflix's case, and market share in Rimm's case.
Had you been part of this disccusion all along instead of waiting for a bounce to say "I told you so," I might have a different opinion of you, especially considering the absurdity of it all when the shorts are sitting on massive profits.
As always, Bilton makes a really strong contribution. Thanks for the clarification.
Lets also be clear here DVL - This article was published in early October, when Netflix was in the $110-$125 range. We're still 20% below that today. Anyone with long-dated puts is doing just fine, despite this rally.
And furthermore, I've been very clear in my articles and comments that I've been short since $280, but thanks for characterizing my play on Netflix as being late to the party.
DVL - This is a long term short thesis. Despite a massive 40% rally, the picture has not changed. In fact, Netflix is much worse off today than it was when I wrote this. Anyone looking to get short this one, here's the chance.
Since I wrote this, Netflix has projected losses for all of 2012, suspended further international expansion, and had to raise capital via issuing shares at $75, despite buying them at $220 in August. There's no question things are getting worse, a stock rally doesn't change that.
I'm only postulating it because Netflix has repeatedly told us that the costs rise as users view more content. Its their words, not mine.
Technician - Remember that Netflix has recently stated they expect EPS losses for all of 2012.
Why the hours watched number means absolutely nothing:
Rocco, enjoyed the article, you've been saying all along that Netflix only still exists because these guys have allowed it. Here's more evidence of that.