Netflix Stock Plunge: Will Reed Hastings’ Hubris Bring Down an Internet Meteor?

Tue Oct 25, 2011 7:20pm EDT

With its stock in freefall and its reputation in tatters, Netflix is at risk of becoming another Internet era Icarus.

Tuesday brought even more bad news to the video rental giant than Monday.

Netflix stock plunged another 35 percent throughout the day after falling nearly 30 percent in the wake of a bruising announcement that the company had shed 800,000 subscriptions during the third quarter.

Analysts told TheWrap that the stock collapse -- a 75 percent drop in Netflix’s market value in four months -- has not yet hit bottom.

Also read: Netflix Stock Plunges Again -- 35% as Investors Bail

At the heart of the meltdown are two factors: Wall Street hype, and the company’s disregard of Main Street.

“The company no longer earns the benefit of the doubt,” said Tony Wible, an analyst at Janney Capital Markets, told TheWrap. “Netflix has revealed a lot about how it cares about investors and customers through its actions. I think it would be wrong to say it cares about those people.”

But the share price was ripe for a fall. For months, Netflix stock has been overvalued, at times soaring above $300 on the excitement over high earnings and a strategic shift to streaming. That hype caused investors to ignore troubling signs that Netflix could not maintain its cost structure.

Also read: Netflix Analyst: 'I've Never Seen a Company Behave This Randomly'

Then came some fatefully poor management decisions. Widespread criticism is now being leveled at CEO and founder Reed Hastings. Long praised by many as a visionary, Hastings is now being slammed as an arrogant, erratic decision-maker who lacks a fundamental appreciation of his customers.

“Reed Hastings is not Mark Zuckerberg,” said Michael Pachter, an analyst at Wedbush Morgan, told TheWrap. “He’s not establishing a new lifestyle, where getting a billion members is more important than profits. Who knows what his whim will be next year?”

Netflix rocketed to popularity and profits as the premier DVD-by-mail service, a digital pioneer that outstripped and out-serviced the established Blockbuster. In the past two years the company has undergone explosive growth, pushing its subscriptions to more than 24 million customers as Blockbuster went bankrupt. (Footnote: a gleeful Blockbuster tweeted on Tuesday: "Dear Netflix, we’re offering special prices & 30-day trials of Blockbuster Total Access to your members.")

Amid all this growth, Hastings chose to shift his movie and TV company to a streaming model, which resulted in the decision to split the DVD business off from the main streaming -- and led to a customer revolt.

Also read: Netflix's Qwikster Move: Hard-Headed Business, Not Greed

Hastings’ strategic choice may have been correct and even revolutionary, yet there was a fatal flaw. The fundamentals of his business – with millions of customers still embracing physical discs – did not support the streaming model at such a low price.

Customers were furious to have prices raised on them for no additional services, and Hastings failed to quell their anger when they filled the company’s message board with screeds about the new subscription fees.

In his talk with analysts, Hastings remarks continued to suggest that the company may have shifted course but still hasn’t found the right message to lure subscribers back into the fold.

“Having separate brands can in theory make sense,” Hastings said to analysts. “However, after the price increase, Qwikster became the symbol of Netflix not listening.”

True enough, but Netflix has not rolled back its 60 percent price increase, which is the source of great customer dissatisfaction. Nor can it. Netflix’s content costs have jumped to $3.5 billion over the next several years, up from the $2.4 billion reported previously, meaning that any discount on subscriptions will be impossible.

Netflix declined to comment for this article.

Also read: Netflix's Streaming Dilemma: Too Fast, Too Cheap, Maybe Out of Control

Even Hastings’ apologies have not sounded terribly contrite.

In an interview with The New York Times last week, Hastings attributed the customer rebellion to overaggressive innovation, and an angry public mood symbolized by Occupy Wall Street.

Hastings told the Times that the company had been tripped up by “overconfidence” and committed the sin of “moving too quickly.” He continued to insist that much of the dissatisfaction had to do with the price increase.

Yet the moment when Netflix’s image problem inched into a public relations catastrophe can be linked with its seemingly spur of the moment decision to spin off its DVD-by-mail business and saddle it with a clunky name like Qwikster. Hastings may have pulled the plug on the plan mere weeks after it was unveiled, but it appeared like the Netflix founder had lost control of the company he built into an entertainment powerhouse.

In Hollywood, the mood was quietly gloating. The studios have have regarded Netflix as a threat to their pay television and video-on-demand deals, even though they were happy to take its money as Netflix set a value for their content in the digital space.

Hastings, a digital entrepreneur, has spent precious little time cultivating relationships in the movie and television industry that is the core of his content business. He preferred to think of himself as a denizen of Silicon Valley, leaving the entertainment business outreach to his chief lieutenant, Chief Content Officer Ted Sarandos.

Meanwhile, journalists, analysts and savvy observers have for months been warning that Netflix would have to raise its prices as its early content deals expired and prices for content went up.

There will likely be more opportunities for schadenfreude.

On Tuesday, 45 million Netflix shares were traded, about six times as the average daily transaction the past three months, suggesting that investors were bailing on the company.

“It just has to bottom out,” Vasily Karasyov, an analyst at Susquehanna Financial Group, told TheWrap. “It has to be left for dead for awhile, before green shoot sprouts and people pick up the stock again. It needs a rotation of investors.” 

Related Articles:  Netflix Analyst: 'I've Never Seen a Company Behave This Randomly' (Updated) Netflix Stock Plunges Again -- 35% as Investors Bail Netflix's Streaming Dilemma: Too Fast, Too Cheap, Maybe Out of Control Netflix's Qwikster Move: Hard-Headed Business, Not Greed