Analysis: Netflix short sellers may yet have their day
NEW YORK (Reuters) - It's been a dismal stretch for critics of Netflix Inc (NFLX.O), the movie delivery company that boasts a superstar chief executive, a stratospheric stock price and some 20 million subscribers.
Just ask Whitney Tilson, a well-regarded investor who late last year published 7,000 words detailing the reasons his fund bet big that Netflix shares would drop. Three weeks ago Tilson admitted he got it wrong -- after the stock reached another new high -- stating he was "no longer confident" in his thesis.
Tilson has covered his short sale, but declined to comment further on Netflix. When asked about other so-called short sellers, he responded, "I don't know anyone else who's been silly enough to disclose that they are short this" stock.
The reason is that few want to admit to betting against a stock that is up more than 1,000 percent since late 2008. But that may soon change. There are growing numbers on Wall Street who believe the time may finally have come to sell Netflix -- or at least stop buying it.
One telling sign is that short interest in Netflix stands at a steep 36 percent, meaning there are plenty of investors who believe the smart move these days is to borrow shares of Netflix and sell them in hopes of buying them back at a cheaper price down the road, profiting from the difference.
What is more, several brokers have recently cut their ratings, including Standard & Poor's and Needham, and shares have dropped 17 percent in just two weeks. Then there is the question of Netflix's sky-high valuation. The $200-plus stock trades at a multiple that gives even Netflix fans reason for pause.
At nearly 50 times 2011 earnings, it carries a richer multiple than Google Inc (GOOG.O) or Apple Inc (AAPL.O), and is in the same league as Amazon.com (AMZN.O), a potential rival, but also a retailer whose annual sales are roughly $30 billion higher than Netflix.
"A lot of people are betting against the stock," said Yoni Jacobs, portfolio manager for Chart Prophet Capital, whose firm recently closed out of a short position on Netflix. "There are two very extreme camps right now: People who strongly believe against it and people who strongly believe for it."
For the bears, it frequently boils down to questions about competition and content.
While Netflix's mail service DVD library is enormous -- comprised of both classics and recent hits -- its $7.99 a month streaming plan is another story. Just two deals, one with Epix and another with Starz, account for most of its movie roster, which is far stronger on older films that current ones.
That largely holds true for its TV offerings, too. Last week, for instance, Netflix signed a content deal with CBS Corp (CBS.N), building on earlier deals for shows from ABC, Fox, and NBC. But critics complain that much of the TV content is too dusty. In the case of CBS, rather than recent episodes of hot shows like "CSI: Crime Scene Investigation," the deal centered on older ones such as "Frasier" and "The Andy Griffith Show."
The risk is what Justin Patterson, an analyst with Morgan Keegan, describes as a "euphoria curve" wherein customers start out watching everything and then drop the service because they feel as though they've exhausted the entertainment choices.
"People are very excited, burn through content and enter this cycle of disillusionment and just turn off," Patterson said. "That's always been a question with Netflix."
Whatever the current limitations on content, these are still early days of streaming, and Netflix is frequently applauded for outmaneuvering far larger rivals Amazon.com, Sony Corp (6758.T) and Apple in delivering movies and TV shows over the web to the living room and handheld devices.
For his efforts, Fortune magazine named Chief Executive Reed Hastings its businessperson of the year in 2010.
"While everyone talks about getting in this space, they are head and shoulders above everyone else at this time," said Eric Jackson, managing member of Ironfire Capital, who has previously written on Netflix. "But everyone sees this is the future, and they are all trying to skate toward where the puck is going."
Apple, Google, and a host of cable, entertainment and telephone companies are making headway with their own plans for streaming video. Another key competitor is Hulu, owned by News Corp NSWA.O, Walt Disney Co (DIS.N) and Comcast Corp (CMCSA.O), the largest cable company.
"All those services are better than Netflix," said Manuel Asensio, a well-known short seller and managing member of Mill Rock Investment Advisors. He holds no current position on Netflix, but calls the stock "grossly overvalued."
Amazon joined the ranks last week, announcing its long-awaited plans to move into the movie subscription business with a new streaming service [ID:nN22281735]. Standard & Poor's analyst Michael Souers responded to Amazon's plans by cutting his recommendation on Netflix to "sell."
Still, Netflix has plenty of believers, many of whom see the stock as ripe for still more gains as the company continues to add subscribers and plans its overseas expansion [ID:nN26184014].
"Competition will come, but it's a question of whether or not it's a long-term threat or a short-term disruption," said Eric Wold, an analyst with Merriman Capital, who has Netflix tabbed as his top pick in media for the year.
By most accounts, greater competition means Netflix could wind up paying more for popular movies and TV series -- or risk losing subscribers. Wold said they can afford to pay up.
"The good news is the content is all fixed costs," he said. "As they layer more subscribers on top of that, their fixed costs get further leveraged with very little variable costs, unlike the DVD model where you've got the cost of shipping."
Wold also sees little problem with Netflix's current stock price. "For a company with that has grown that fast -- they've shown the past couple of years they've grown an average of 50 percent -- I'm willing to pay a pretty high multiple for it."
(Reporting by Paul Thomasch, editing by Dave Zimmerman)
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