Don't Believe the Hype

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

Public Enemy’s hook for Don’t Believe the Hype starts up in my head when I see companies suddenly receiving positive attention and hype after suffering a rollercoaster downfall due to numerous letdowns in recent months.  What makes it worse is that the media and public opinion take a shift on major business networks and it only takes one or two analysts to get the general consensus shifting the other way.  In this article I discuss 3 unrelated companies that have been hyped up in some way the past year or are now, being hyped up again.  I just say Don’t Believe the Hype.

Netflix

Back in August 3rd of this year I published this article Netflix is Obsolete to This Star.  The thesis I had then is what I still have today – the rise in Coinstar’s Redbox and other streaming video companies will slowly make Netflix (NASDAQ: NFLX) obsolete.  I received criticism as well as some support for the article.  Since my article was published, however, Netflix has soared 70% in share price.  Despite this gain, the stock is still down nearly 69% from its July 2011 highs that exceeded $300/share.

It now appears that every major analyst is jumping back on the movie train that includes a recent Morgan Stanley price target raise from $80 to $105 on December 12th.  What is different now is that Redbox will be now launching an instant video streaming service that starts at $6 a month.  This is 25% lower than the $7.99 fee that Netflix currently charges for streaming video.  Furthermore, the deal is even sweeter for Redbox because they also offer four one-night DVD rentals from their kiosks and for an extra $3, customers can also rent Blu-ray instead of DVDs.  This price plan crushes what Netflix currently offers – which appears to fluctuate every few months for the worse.  The price per plan for DVDs-by-mail varies from $4.99 to $43.99 per month based on the number of DVDs that a subscriber may have out at any given point.  The cost goes up with surcharges ranging from $2 to $4 per month for Blu-rays.

I don’t feel Netflix has any room in their margins to cut subscription prices to compete with Redbox and future competitors.  Their net profit margins already declined from 7.06% in 2011 to 0.85% as of 3rd quarter 2012.  On top of this they traditionally enter into multi-year multi-million dollar streaming content licenses with studios and other distributors with license fees extending up to 5 years.  In the 9 months ended September 30, 2012, streaming content liabilities increased $631.8 million.  The company had $5.7 billion in total obligations at the end of the 3rd quarter and the market cap for the stock is only $5.1 billion.  The more Netflix tries to acquire both domestically and globally, the more the cost of revenues increase and the lower the margins will be for the near future in my opinion. 

Furthermore, CEO Reed Hastings has had some controversy recently over using Facebook to communicate with the public and Netflix members.  He lists a statistic that members are enjoying “nearly a billion hours per month” of Netflix.  I understand why the SEC has issues with this type of communication but I don’t see why Reed Hastings cares about this number.  Last time I checked, Netflix generates revenues by subscriptions and not how many hours per month customers use Netflix.  Perhaps, this is part of a new price plan coming shortly?

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NFLX Total Return Price data by YCharts

Zynga

There are bad stocks and then there are really bad stocks.  Then there is Zynga (NASDAQ: ZNGA).  Zynga’s motto is “Connecting the world through games.”  Perhaps they should add the words “for a loss” at the end of it if it is to match anything they have done business-wise since going public on December 16, 2011.. 

Zynga states they are the world’s leading online social game developer with approximately 311 million average monthly users (MAUs).  Where they succeed in volume of users, they fail horribly in terms of generating net income.  As a game user myself of several iPhone games by Zynga, I can say I haven’t paid a single cent for any of the games.  Zynga generates revenue primarily from the in-game sale of virtual goods and advertising.  These can include extra levels, different costumes or vehicles, to additional game features.  I just don’t understand who is buying these virtual items and I doubt I am alone since the company hasn’t produced a single positive EPS quarter since going public.  For those that do succumb to these virtual rewards and items, 100% of the customer’s money isn’t even going to Zynga.  Since Zynga primarily distributes their games through Facebook, Zynga loses at least 30% off the top for each purchase to them.  Zynga’s big 3 moneymakers of FrontierVille, FarmVille, and Mafia Wars, which make up over 50% of all revenue for Zynga, saw 3rd quarter revenue decreases of $36.9 million, $22.3 million, and $22.1 million, respectively. 

Zynga’s hype and their association with Facebook is what have led to huge disappointment for shareholders.  Since going public the stock has declined over 72% and there doesn’t seem an end in sight.  In my opinion, the source that hurt Zynga the most was that they believed in their own hype.  Their first game Texas Hold’Em Poker started a chain reaction of venture capital funding, big promises, and senseless acquisitions over the past 5 years.  The hype built up to the inevitable IPO a year ago.  The only change now is that their business flaws are a lot more public now.  If there is any doubt that there is uncertainty in the future of Zynga, just check out the ‘Risks Related to Our Business and Industry’ section of their most recent earnings report.  

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ZNGA Total Return Price data by YCharts

Molycorp

From March of 2009 to April of 2011, Molycorp (NYSE: MCP) rose over 650% in share price.  The company provides rare earth and molybdenum products to companies.  Rare earths are a group of 17 metallic elements (Molycorp provides 13 of the 17) of the periodic table with very unique properties that are widely used in energy and lighting technologies that include hard drives, fuel cells in electric vehicles, wind turbines, polishing powders and catalytic converters.  Rare earth elements are not exchange-traded in the same way that gold and silver are and as a result huge inflation can occur and has occurred to drive prices up.  This material inflation is mainly what helped propel Molycorp’s share price as announcements that included buying Neo Material Technologies (Molycorp Canada) and a surprising quarter helped hype up the stock to unpredictable highs.

Now prices for the Resources segment’s primary products (cerium, lanthanum, neodymium, and praseodymium) have significantly decreased and this has caused sales to drop to $84.1 million for the nine months ended September 30, 2012 versus $227.4 million a year ago.  The Molycorp Canada acquisition hurt the Chemicals and Oxides segment.  Magnetic Materials and Alloys and Rare Metals segments were impacted by increased cost of sales and adjustment to inventory as part of the Molycorp Canada acquisition as well.  Overall, net profit margin in 2011 is nothing like it has been this year so far.  In the last 3 quarters of 2011, net profit margins were 45.11% (June 2011), 30.79% (September 2011), and 17.86% (December 2011).  In the first 3 quarters of 2012, net profit margins have been -7.49% (March 2012), -67.37% (June 2012), and -10.57% (September 2012).  Looking back to quarters prior to 2011, you see that Molycorp consistently had negative net profit margins.  In fact, the average net profit margin for the last 5 years has been -197.6%! 

In my opinion what really happened with Molycorp is the perfect storm of what hype can do to a stock.  Commodity and material prices go up and down all the time for all mining companies.  This isn’t ground-breaking news.  During its run to over $70/share (today it is hovering around $10/share), Molycorp was mentioned nearly every other day among various business news channels.  Analysts couldn’t say enough good things about it and investors quickly bought into the hype as the price increased.  I believe it is very similar to what has happened to the Fiscal Cliff of this year.  The term ‘Fiscal Cliff’ is a huge misnomer of what might happen at the end of this year that puts a lot more fear into the average citizen than necessary.  The cliff is not even a cliff in any sense of the word and it isn’t something that was just created or discovered recently.  It has been in place for over a decade and you could argue longer as a long-term consequence to how government financial policy has changed.  Rare earth elements are not even rare in the pure definition of the term ‘rare’.  They are abundant in the Earth’s crust and are only subject to mining techniques and whether areas are economically exploitable.  Additionally, like the Fiscal Cliff, rare earth elements are not something that was just created recently either.

Overall, Molycorp as a business relies on way too many outside factors to really grow consistently as a business.  They rely on various technology companies to buy their rare metals but also need to anticipate what China-based producers and suppliers are doing at the same time in their rare earth production.   

<img src="http://media.ycharts.com/charts/6e9d6edaace8f78d77f59dcd4ed2b8f0.png" />

MCP Total Return Price data by YCharts

Don’t Believe the Hype

Hype is derived from the word hyperbole which itself means exaggerated statements or claims not meant to be taken literally.  Netflix at one point between 2010 and 2011 was viewed as changing the way we watch television as some predicted it would replace cable TV entirely.  Zynga believed that lots of monthly users equals in lots of income.  They have seen this doesn’t work when their business model is overshadowed by the fact that the majority of their products can be consumed for free.  Molycorp showed that when the word ‘rare’ is associated with the products you provide, stock prices can be hyped up to unrealistic levels.  I just say Don’t Believe the Hype.


mikecart1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Netflix. Motley Fool newsletter services recommend Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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