* JP Morgan, Citigroup cut ratings to neutral
* Janney cuts to sell, others slash price targets
* Shares close down 35 percent
By Lisa Richwine
Oct 25, Wall Street is losing confidence that
Netflix Inc can quickly reverse subscriber defections
and cover mounting costs with growth in streaming, pushing its
shares to their largest one-day decline since 2004.
The stock nose-dived in heavy trading on Tuesday, a day
after the company provided uninspiring guidance as it grapples
with the fallout from an unpopular price increase and recent
CEO Reed Hastings, once viewed on the Street as a CEO who
could do no wrong, is struggling to restore his and his
company's tarnished credibility following a chain of strategic
about-faces and unpopular moves, starting with a miscalculated
price increase announced in July.
It culminated in Monday's shockingly dismal subscriber
numbers and forecast, and a prediction for a loss, as the
company pursues a costly global expansion.
Several analysts cut their ratings or slashed price
targets, pointing to challenges such as rising costs for online
movie and television content and international expansion.
"We believe the (Netflix) model is unsustainable, as the
company faces rising costs that it hoped it could pass onto its
(subscribers), who appear unwilling to do so," Janney Capital
Markets analyst Tony Wible said in a note to clients. The
brokerage cut its rating on the stock to "sell."
In the second-heaviest day of trading in the company's
history, Netflix shares closed down 35 percent at $77.37 on
Nasdaq -- 75 percent lower than their high of about $305 in
July. It was the biggest one-day drop since October 2004, when
the much smaller company lost 41 percent after it warned of
growing competition. That day also saw the highest trading
volume for Netflix shares.
The recent downward spiral for the shares started in July
when the company that shook up Hollywood with its DVD-by-mail
service announced a price increase for subscribers who wanted
both DVDs and online streaming. Since then, its market value
has shrunk by about $9.76 billion.
Netflix had drawn heavy short interest when its shares were
on an upward tear and traded at nearly 50 times 2011 earnings.
One investor who had famously shorted Netflix shares in
late 2010, Whitney Tilson, said on Tuesday he was taking a
small, long position. Tilson, who had warned about the
company's high valuation, had closed his short position in
February as the stock kept rising.
In an email on Tuesday, Tilson said it was "frustrating to
see our original investment thesis validated, yet not profit
"In light of the stock's collapse, we now think it's cheap
and today established a small, long position. We hope it gets
cheaper so we can add to it," Tilson said.
Another investor who has shorted the stock at various times
this year remained bearish on the stock. Yoni Jacobs, portfolio
manager for Chart Prophet Capital, said he covered some of his
short position on Tuesday but saw challenges ahead.
"I do expect Netflix's problems to continue," Jacobs said,
in part because "I see them continuing to struggle with
As of Oct. 14, roughly 18 percent of Netflix shares were
EXPANDING AS CONTENT COSTS RISE
On Monday, Netflix -- which is trying to recover from the
roughest patch in its nearly 15-year history -- forecast a
loss for the first quarter of 2012 as it spends more to expand
"Expansion into the U.K. and Ireland -- a positive
longer-term -- comes at the same time domestic growth is
slowing and content costs are building," said J.P. Morgan
Securities, which downgraded the stock to "neutral" from
"overweight" and slashed its price target to $67 from $205.
Citigroup also downgraded the stock to "neutral."
Coming into the session options traders had been expecting
positive news. In the 10 trading sessions heading into Netflix
earnings beginning with Oct. 11, investors bought 1.24 call
options - an option to buy the stock by a given date at a
specific price - for every put option on major U.S. options
exchanges, according to Joe Bell, senior equity analyst at
Schaeffer's Investment Research.
"People were betting on a better report than what was
released," Bell said.
Schaeffer's total put-to-call open interest ratio (SOIR)
based on the front three months of Netflix options stood at
0.99 as of Monday. That's lower than 90 percent of the readings
over the past year, which shows more calls added than puts in
recent months, suggesting expectations for gains in the stock
in coming months.
Netflix, in a letter to shareholders, admitted it had "hurt
our hard-earned reputation" but said the company would return
to profitability by "increasing our global streaming subscriber
base faster than we increase our costs."
B. Riley & Co analyst Eric Wold said he was optimistic that
Netflix's domestic positioning and market share potential would
remain strong and international investments would pay off. "We
continue to believe long-term investors will be rewarded," said
Wold, who maintained his "buy" rating.