The attacks on Netflix‘s stock are finally starting to take their toll.
A big part of the reason Netflix is going to down? It’s being hammered by Whitney Tilson and other short sellers who think it’s due for a correction.
Whitney’s chief concern: the cost of streaming content is going up and Netflix’s margins will be squeezed.
For a more detailed, thorough look at the bear’s position on Netflix, read on. We’ve summarized Tilson’s big presentation on why his fund is short the company.
Here's what Whitney Tilson writes, 'By any measure, Netflix's valuation is extremely rich. Based on yesterday's closing price, it trades at 67.4x trailing EPS ($2.65), 63.1x the high end of the company's EPS guidance for the full year 2010 ($2.83), and 46.7x consensus analysts' estimates for 2011 ($3.82). It also trades at 4.6x sales. In short, the stock is priced for perfection and any misstep would likely trigger a huge selloff.'
Netflix was able to kill Blockbuster and other lumbering giants with relative ease. Now it's about to face a much more nimble group of foes. Hulu is picking up more content. iTunes is a huge force. Amazon is expanding its streaming. And Google is also moving into the space.
Is Reed Hastings and his crew really all much smarter than Steve Jobs, Jeff Bezos, and the Google guys? And as he fights them can he protect the company's margins?
Netflix's old business model: Pay for a DVD once then rent unlimited amounts of time. Netflix's new business model that has people excited: Pay a lot of money for a limited selection of streaming content. With the old business model, Netflix could get any content it wants and rent it. With the new business model it has to deal with rights owners which can get very expensive, very complicated.
If you're looking for great streaming content on Netflix, you're going to be disappointed. Tilson aggregated the top 50 grossing movies ever, the IMDB's top 20 ranked films, Rotten Tomatoes' 20 top ranked movies, and the 10 top-selling and top renting DVDs. He then looked at the streaming options for those films on Netflix versus iTunes, Vudu, Amazon, and cable. Netflix had the fewest options.
He did the same sort of test for TV shows based on TV Guide's list of 100 most popular shows and came up with similar results.
Netflix has reportedly taken on new streaming contracts valued at $420-$625 million annually. This is the new normal for Netflix streaming deals -- $200 million per year or so from content partners.
Tilson estimates that Netflix will only see costs drop $150-$250 million next year as people need few DVDs delivered. That is not enough to offset the new rising costs of streaming.
Netflix's costs will rise to $42 to $65.4 million per quarter thanks to its new streaming deals At the low end, that 64% of Netflix's Q3 profit. At the mid-point it wipes out Netflix's profit.
You can see the costs of acquiring streaming content and DVDs diverges from the amortization of content library in Q4 09. Eventually that amortization will have to match the costs. When that happens look for Netflix to get hurt.
Tilson says his analysis of Netflix churn shows that it lost 30 million customers in the last decade, which means it has signed up around 47 million customers in the last 10 years, since it has 16.9 million subscribers right now. If it wants to double its current subscriber base, it will have to add another 47 million subscribers. How can it do that?
In the future, it's possible cable companies will start charging tiered rates for web usage. Considering Netflix streaming eats up lots of bandwidth, it's possible people will be less likely to use Netflix since it will be expensive.
This one is a real stretch...but Tilson argues the loss of a key exec for no real reason is a bad sign for the company. It should be noted that Reed Hastings says Barry McCarthy left because he wants to be a CEO somewhere and it wasn't going to happen at Netflix.
This is another stretch, but there is talk that the law that allows Netflix to buy a DVD once then rent it repeatedly could be undone. If that happens, then Netflix's whole business could be upended. That's a big IF.
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