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Netflix: Upload Or Download?

|Includes: Netflix, Inc. (NFLX)

Published October 27, 2012

Hello everyone. It's a little bit after one in the morning here in Maryland, and so it's about time to call it a night. However, I did promise some comments about Netflix before I turn in. In a pretty flat market today, Netflix took off to the upside throughout most of the afternoon. Apparently, a rumor was circulating throughout Wall Street that Microsoft was interested in acquiring the company.

After several point of upside went by, I decided to purchase some November 70 puts in Netflix, but it turned out that my timing was off as the stock continued until very near the close. My impatience aside, most of the move can be attributed to the fact that an overwhelming percentage of the company's shares are short and this fueled a good part of the meteoric rise.

The question now becomes, what are the odds that Microsoft may actually pursue a purchase of Netflix? Given the strong cash position that Microsoft has, it would certainly be an easy purchase for them to digest. However, they would be buying a company who is struggling to find a profitable strategy in an increasingly competitive market. Amazon is making great strides with its streaming media business, and Apple has been rumored to be on the verge of entering the fray as well. The attraction to Microsoft, of course, would be to get a jumpstart if they want to compete in this space.

My feeling is that Microsoft is unlikely to make a bid. Microsoft management has failed to create new and interesting revenue streams for years now, and would have to rely on the existing management team with Netflix if they moved forward. Given the fact that Netflix CEO Reed Hastings is seen as being less than stellar by both investors and analysts, I can imagine Steve Ballmer becoming enthused about that option.

Finally, Netflix posted mediocre revenue and earnings earlier this week, and built on that news with tepid guidance for the future. The stock cratered almost $10 after the earnings announcement, a sign that big money voted with their feet. Most interesting to me is that I don't believe Netflix would have presented such a lackluster forecast if a potential takeover was in the offing. Rather, I believe they would have been decidedly more upbeat, attempting to keep stock prices elevated so that Microsoft would be compelled to offer decidedly more money for the company if they were interested.

Anyway, I find myself down on my put position, but not particularly interested in taking the loss right now. My downside is completely protected if the takeover does come about, but if the more likely scenario unfolds and lack of an announcement leads to weakness in the shares, I believe I can back out of this with a pretty good profit in the next week or two. Whatever you do, use common sense, and never let a position get so large that the tail wags the dog.

Disclosure: I am short NFLX.