Netflix ($NFLX): Reed, NOW You Have Some Really Tough Questions to Answer

The Fundamental Problems Facing Netflix Are Known
In fact, this blog has listed many of them here. As a business model, Netflix controls few, if any, of the inputs that would determine its success or failure. That is a big problemo, but this blog has already pointed them out, before the warnings made by the company. It could be said, if you were a fan of management, that Netflix filled a void that existed between suppliers of content (studios) and delivery mechanisms (cable, tv, etc). No need to rehash that here.

Wasn't the Loss of Subcribers a Material Fact?
The troubling thing at this point, and perhaps most damaging, is the fact that management has held onto its business model for too long, without selling itself, and without putting itself in the monopolist position. Perhaps it could never put itself in the monopolist position in the US because the studios and the cable systems would never allow it. Fair enough.
However, given that the stock price was predicated on the growth of subscribers, and that Netflix would have had knowledge of the loss of subscribers, the fact that they have revealed this just now, without more clarity during the quarter is shocking, and will subject Netflix' management to class action lawsuits by investors who will claim, perhaps rightfully so, that Netflix management was negligent by not reporting an obviously material fact. This will weigh on the upside potential should a potential bidder emerge.

Who Would Buy Netflix? Ignore the Rumors
Much like $RIMM, there will be some speculation regarding Netflix as a takeover play. Unfortunately, given the fact that most of the weakness are known, and that those weaknesses are turning into a negative growth rate, enormous (insurmountable) barriers exist to repel any potential bidders. Just who would buy Netflix and why? Apple or Amazon could potentially buy, but to what end? Both have substantial cloud presences. Both have superior relationships with suppliers of media content. Maybe, one or the other would buy Netflix' portfolio of existing contracts to obtain exclusivity. Pixar has just signed with Netflix, and that could potentially be a jewel. The foreign expansion plans are still in their infancy, so that is still a wait-and-see proposition. In short, we are back to salvage value here: the value of the existing contracts could be sold to whom? A consortium made up of competitors? Unlikely. A buyer of existing subscriber base, who can change loyalties with a single click? Unlikely. This is probably not new news to Netflix' management, which has flip-flopped over the past couple of months over these problems. Unfortunately, the problems cannot be solved without selling itself to the highest remaining bidder, who would now face anger from existing shareholders. Still a sell. Even here.

Netflix ($NFLX) Dumps Qwikster Very Qwickly

Netflix Changes Course, and More Questions Get Raised
When Netflix ($NFLX) announced a split between its video streaming and DVD/Video Game delivery services, this blog suggested that it was the right, albeit unpopular, move. Today, when Netflix announced that it had changed course, and ended the idea before it got launched, the stock rocketed in pre-market trading to $128.5/share. However, the afternoon saw a dramatic turnaround, and the stock hit a low of $107.31 before recovering to above $111 a share.

Now, The Questions
The question is why the change of course. There could be three potential scenarios that this post will address.

a. Netflix is listening to its customers. This is what Netflix' management has said in public. This is what management would like you to believe. This is most likely true, in part. The company was pilloried in the press, and on its blog, with complaints. However, the problem with that is that there are now two other scenarios.

b. Netflix has seen a massive bailing out by customers. It is more likely, although unconfirmed, that Netflix has seen a huge outflow of customers. Given the negative attention resulting from the loss of Starz, and the upcoming Kindle Fire (with accompanying Amazon Prime video streaming service), management probably had to stem the tide. That cannot be good.

c. Netflix may have given up its only real hope for survival. This is most troubling. The way forward, perhaps the only way forward, over time, is to partner with either a consortium of studios, or a consortium of cable companies (unlikely). Netflix controls absolutely none of the main sources of entertainment. It is entirely subject to agreements with studios, etc, which control the creative process. By re-combining the DVD delivery service with the streaming service, it has lost the only way for it to sell itself, or to permanently combine with sources of distribution. Streaming service itself can be a viable business model. In countries with acceptable download speed, there is IPTV, which streams live TV, and video on demand, and doesn't use the traditional cable companies. Could that occur in the U.S.? Well, Time Warner, Cablevision, Direct TV, etc charge an enormous amount of money to its customers. An alternative would be welcome. Unfortunately, recombining DVD delivery with streaming effectively ends a clean path of exit or M&A for Netflix.

Finally: you know the company is in trouble, when Saturday Night Live does a parody, which can be seen here.

Disclosure: The writer has no position in Netflix, but has entered into daytrades, with the opening position as short.

Let's Remove the Names and You Decide ($NFLX)

What If This Was an HBS Case Study?  Let's see. UPDATED

Acme Inc:
Doesn't control access to supply of inputs necessary to distribute.
Doesn't control pricing to supply of inputs neceesary to distribute.
Potential competitors have greater power to influence access and pricing of inputs than Acme Inc.
Potential competitors have MUCH greater access to capital, and a far wider range of related products.

One last thing, Acme Inc's real name?  Netflix (NFLX)
Insert whatever industry you want, the facts above are true, and the conclusion would be that Acme Inc is doomed.  When, not if, unless there is a game-changing event (like M&A).

That doesn't mean that you can't make lots of money trading NFLX.  The Acme Inc summary above tells you that extreme caution is necessary in doing so.  You cannot predict the movements because (presumably) there are more people with more money pushing around the prices for their own reasons.  However, if you are long, then you must remember that the facts regarding Acme Inc are incontrovertible until proven otherwise. 

We can talk all about momentum and technicals, which are fine when there is a conflict of information regarding the Acme Inc's of the world.  In the short run, those factors may certainly dominate the price action for a day, or a week, or even longer.  My only point: when the fundamentals are THIS negative, then be quicker than usual and close your position (long or short) if you are proven wrong, given your timeframe. 

That all said, feel free to click on the left, where an advertisement is almost certain to appear, compliments of Google AdSense, for your free trial.  How Yahoo! (YHOO) missed click advertising is beyond imagination.  That it has survived that colossal mistake is no small achievement, I guess.  Perhaps that is the subject of another post.  Nah.  Nothing much more to say than that.

UPDATE: Splitting up the company into two individual parts, one which is dvd/video game delivery and one which is streaming is the best solution among a number of bad alternatives. The dvd/video game can be seen as a commodity, whose competition will include Blockbuster kiosks, GameStop, et al. The streaming business, however, is built to be sold. Its subscriber base can be sold to any number of parties, from the media creators to Amazon to cable companies to TV manufacturers. That is the shareholder-maximizing move. That doesn't necessarily mean that it will be easily sold, but it is clearly an exit path. Management should be applauded for this move, since it does present an alternative. Assigning a multiple, however, is another matter. The issue now will be what multiplier gets assigned to the streaming business. So unless the streaming business gets sold to Apple, which along with an actual TV, could be the entire back-to-front delivery package, the other potential bidders may have large misgivings because of the pricing of access to media. That leaves Google, Apple, or a partnership with Hulu and studios. The issue is that the pricing of the streaming business is highly contingent on the quality of the potential buyer. Absent a buyer, all of the original post remains true, and Netflix ($NFLX) could see much lower prices, even from here.

Netflix or RIMM: Which is Worse? Its Close

Comparing Netflix ($NFLX) to Research in Motion ($RIMM) Isn't Quite Right
Both stocks had very bad days yestereday.  Netlfix' bad day started before the market opened and Research in Motion's bad day started after the market closed.  However, that is where the similarities end.

Netflix' troubles have been highlighted here.

Netflix Has a Brand Name, Research in Motion Doesn't
There is hope for Netflix at some level, i.e. it can still form partnerships with media companies in exchange for equity.  It can try to secure licensing agreements for content in international markets (unlikely, since the blueprint already exists).  In other words, Netflix has a brand name which needs to be levered into returns for equity holders.  Fast.
Research in Motion, however, is in a huge amount of trouble.  It is rapidly becoming irrelevant in the smartphone market, as it gets dominated by Android phones and of course, the iPhone.  Enterprise email/server infrastructure?  Being bypassed although it will be a while for the largest companies to entirely shift this infrastructure away from Blackberry due to security issues.  If this gets moved to the cloud in a viable way, it will mean the death knell for RIMM.

Worse: RIMM is Running Outta Cash
It has been widely publicized that the RIMM tablet is a disaster, and that the marketshare of RIMM's smartphones is dropping.  Perhaps most telling is the fact that RIMM itself used 50% of its cash in the last quarter, including something like $750 million on Nortel's patents.  The return on those bids better come quickly, because management has lost the faith of the investing community.
RIMM's backers suggest that the enterprise franchise and patents make RIMM a value play.  Granted, the enterprise franchise could be worthwhile but the problem is that users don't want to use Blackberrys, other than the 60 year olds who have been using them for 10 years.
Patents is another matter.  People mistakenly believe that these are very valuable.  Well, lets like the courts decide.  Has Apple launched lawsuit after lawsuit attempting to block the sale of the Playbook?  No.  Apple has its sights set on the Samsung Galaxy Tab.  Apple knows that Samsung is Apple's only viable competitor, with not only design but production capabilities as well.  RIMM?  Not worth of Apple's attention.  That is all you need to know about the value of RIMM's intellectual property.

Correction:  Netflix and RIMM Do Have Something in Common
Both are sells, and while you can daytrade or do whatever you would like in the very short term, and will remain so until any of the facts above are proven to be wrong. VWAP, EMA, SMA, Bollinger, MACD: all of them will merely be numbers that get sliced through unless something dramatic occurs, and soon.