Should Investors Give Netflix and Reed Hastings Another Chance?

Kevin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Okay, I admit it: I was one of the investors burned by the Netflix (NASDAQ: NFLX) flame-out last October. I made the classic mistake of buying high and selling low. I'd be lying if I said emotions didn't come into play, but I should have known better.

I'd faced a worse situation with Sirus XM (NASDAQ: SIRI) when I bought 1,000 shares right after the FCC announced they were cool with the merger. I bought another 1,000 when it dropped another dollar in price and yet another 1,000 when it dropped again. Still, I held on, believing it would come back...more hoping, actually. I'd ignored it for awhile in disgust. Then one day I saw it at 16 cents and said, "What the hell?" and doubled down on it, picking up another 3,000 shares. It was a Hail Mary pass that had paid off. It hit 1.10, and I dumped the whole lot of it, pocketing a $1,000 profit, swearing I'd never touch that stock again, and I never did. The expenses of acquiring content and talent like Howard Stern, who'd been given a ton of shares and was dumping so much of it the share price suffered, competition from newcomers like Pandora, and more were all it took for me to say, "Hasta la vista, Sirius XM...and good riddance."

I'd lost all my investment on a couple stocks in the past, Loudeye and Netbank, so I knew from painful experience a stock could tank and keep on tanking into oblivion. 

So, why did I sell Netflix and not double down as I did with Sirius XM? I held on as the stock hit its all-time high in July and continued to hold as it slipped. I still believed in the company when I first started buying shares, but a lot has changed since then, namely:

1. Reed Hastings had been steadily selling his shares of Netflix--a lot of shares. Okay, not necessarily a red flag. After all, you can't blame the guy for wanting to enjoy his money and buy some toys, but still something to be aware of.

2. The price increase they announced during the summer was a shock to subscribers. A gradual increase over a period of time would have been better. One of the main reasons people join Netflix is the price. They could have taken a tip from the cable companies here.

3. Qwikster (a. Splitting the company? b. Separating their rating database. c. Making customers maintain two separate accounts without an option to link them. d. Not checking to see if the name was available on Twitter. [It turned out to be owned by a pothead. Maybe he was sharing his stash with Hastings.] e. This came too soon (and shouldn't have come at all) after the price increase nightmare. f. "Qwikster"????) They never even sent out a survey to see how a segment of their customers would react. Well, they heard back from their customers loud and clear, didn't they?

4. Content providers are charging more. This was to be expected, but it affects Netflix's bottom line nonetheless. Netflix is at least creating some of their own content now. I think that's a step in the right direction, but we'll see how it pans out.

5. Larger companies like Apple (NASDAQ: AAPL), Google (NASDAQ: GOOG), Amazon (NASDAQ: AMZN), and now Comcast (NASDAQ: CMCSA) who have more resources have entered the streaming arena, which creates more competition and also makes it easier for content providers to charge more. The competition continues to grow while Netflix's moat evaporates. Wait. Moat? What moat? Oh yeah. There is no moat, not anymore. They had it with their DVD rental business. Once they moved to streaming they lost it. You can't blame Netflix here though. They had no choice. Streaming is the future. It's just going to be a lot harder for them to hold onto their customers from here on out. Customers have already been complaining about the lack of good content on their streaming service. Netflix is working on it, but it won't be easy, and I doubt they'll ever equal the breadth and quality of content of their DVD rental business.

6. Inappropriate share buybacks. Why would a company buy back shares when they're at their highs and generally looking overpriced to a lot of investors? A lot of companies do this, I know, but it still doesn't make sense except to inspire confidence in the stock and artificially inflate it, which is the wrong reason for executing a buyback plan. This wasn't an efficient use of capital. Later on, after the October crash, they announced that they'd raise about $400 million by selling stock and bonds, presumably so that they could acquire more content. Why not just avoid the buyback in the first place? Then at least they wouldn't have needed to sell more shares later on. At the very least, this sounds like management doesn't know what it's doing. It certainly isn't a shareholder friendly strategy, and it makes the company look like a basketcase.

Ultimately, I sold because Netflix's story had changed. I saw it coming, but I didn't act until it was too late. Lesson learned. Everyone makes mistakes, but Netflix made a few too many for my taste. I can no longer say I believe in them. I think the most likely best case scenario for them at this point is to be acquired by a larger company like Apple, who is able to afford the content which is Netflix's bread and butter. Still, they may surprise most of us and become what they were in DVD rentals, but that will be a rough road to follow and I doubt they'll enjoy the dominance of their industry they once did. I won't bet against them because the streaming business is still in its early stages, but there's too much uncertainty and too many questions regarding what Hastings was thinking when he announced Qwikster and the price increases. Until their story changes significantly--and I don't see how it can at this point--I'd say Netflix is one movie not worth the price of admission.


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