Netflix: To Short or Not To Short?

by Lawrence Meyers | July 25, 2012 10:00 am

Netflix (NASDAQ:NFLX[1]) reported earnings[2] on Tuesday, and while they beat expectations, questions remain for this investor about its future.

Part of the problem is that I simply don’t trust CEO Reed Hastings anytime he makes a public statement. So while I wouldn’t rely on a management statement anyway in my analysis, anything Netflix management says actually causes me to raise an eyebrow.  I think of Netflix as a crumbling kingdom, while the emperor runs around, hitching his pants up, trying to calm the citizenry as bricks tumble from the parapets.

The numbers themselves aren’t so great when you analyze them closely. Every revenue and expense metric was more or less flat, with the exception of advertising cost, which was down $17 million. That’s what makes the difference between quarters, and the only reason Netflix actually reported any profit at all in the quarter, compared to a $68 million profit in same quarter last year. The reason for that difference is because Netflix added about $100 million in revenue, but subscription costs for that additional revenue amounted to $155 million.

Free cash flow, which had been $153 million in 2010 and $230 million last year, is a mere $17 million so far this year. All this is coming on an increase in total new subscriber increase of about 1.9 million year-over-year, or about 8%. So even though subscribers are increasing, and revenue is increasing, the company’s profit and cash flow is declining.

And the company says subscriber growth isn’t likely to come near the 7 million it anticipated for the year, that it would report anywhere from a 14-cent profit to a 10-cent loss next quarter. I’m going on record to say it’ll be a loss.

There’s also a fly in the red envelope. Although Netflix said the Post Office’s closing of certain centers hasn’t impacted their operations, one wonders if this variable may create headaches for them going forward.

Now this is all bad news, but how does it stack up in a historical context? Does the Emperor have no clothes, or does he have plenty and the citizenry is just ignoring it?

Well, it was just about a year ago that Netflix stock began its plunge from the $300 range after announcing its price hike. After hitting the $200 mark in August of last year, the stock fell off a cliff to $130 in September when Mr. Hastings created the two-website initiative[3] that angered everyone all the more.

Not content with the clothing it had shed already, Netflix peeled off another $53 drop by the time Halloween came around, after announcing it lost 800,000 subscribers[4] in its Q3.

So far this year, then, I think it’s safe to say the Emperor is looking pretty sad in his underwear … and those are about to get swiped.

I’ve said before that Netflix was a short[5]. It has liquidity problems[6] regarding competition in streaming video on top of its other issues, which now includes a streaming competitor in Coinstar (NASDAQ:CSTR[7]). Given the drop in Netflix stock today, is it still a short?

It’s a tough call because there are enough Netflix believers that a short squeeze still could occur. And NFLX did jump back up over the past few months. Overall, though, I think shorting the stock here has a pretty good risk-reward curve.

This also is where a little technical analysis comes into play for me.

With the severe break below the 20- and 50-day EMA having now occurred, and a few follow-through days where the stock does not rise above $75, I’d go short. However, I’d set a good-till-cancelled stop at $86 if it pops. I would further add to your short if the stock pierces the $60 barrier on strong volume.

Lawrence Meyers is long CSTR. He is considering shorting NFLX in the next eight trading days.

  1. NFLX:
  2. reported earnings:
  3. created the two-website initiative:
  4. announcing it lost 800,000 subscribers:
  5. I’ve said before that Netflix was a short:
  6. liquidity problems:
  7. CSTR:

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