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Shorting Netflix


collegeinvestor
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What do you guys think about this idea. With book value of roughly 200 million and the stock trading with a stock trading at 5 billion dollars this will be an interesting one to watch. In addition they have roughly 200 million in long term debt. If this business was so good why would they need so much debt. Also, it seems as though revenue growth rate isn't enough to warrant this market cap in my opinion. Let me know this should also be interesting to watch.

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I just watched a Canadian TV show where they were interviewing the CEO of Zip.Ca (canadian equivalent of netflix) and the guy said he doubled it's revenues in the last 2 years. Plus, streaming is coming big time, I didn't do the analisys but bandwidth is probably much cheaper then the transport fees. which means higher margins.

 

The 200M of debt you are referring means that they will need to pay interests of I don't know, maybe 14M. With a FCF of around 100M their cash flow can certainly pay down the interests.

 

At 40 times earnings the market is certainly putting a lot of optimism into their forecasts but that's no thesis for shorting for me. I look at about 40 stocks a week and out of those 40 there is usually 10 that almost make me puke. It doesn't mean I short them.

 

BeerBaron

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yeah this should be interesting to watch. I dont short stocks either but just thinking about how highly priced this stock is makes me think. How much more can this company grow and where will this growth come from? If you think about it the IRR of return you would get on this stock would be less than a Us treasury bond. This company is not like apple where they can grow in other segments. Are they going to start a netflix in china haha. I just dont understand what people see in this business.

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yeah this should be interesting to watch. I dont short stocks either but just thinking about how highly priced this stock is makes me think. How much more can this company grow and where will this growth come from? If you think about it the IRR of return you would get on this stock would be less than a Us treasury bond. This company is not like apple where they can grow in other segments. Are they going to start a netflix in china haha. I just dont understand what people see in this business.

 

the shift towards instant streaming will probably dramatically lower their expenses, take some time to look at how much they spend on postage right now. so the cloud is a major tailwind in their favor since they have invested in instant streaming boxes and their subscriber rates are climbing.

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the shift towards instant streaming would create less barriers to entry versus the current Netflix business model. Is it easier for me to start a website that streams movies or start a whole network involved with printing dvds and sending them around the country with scale?

 

If you think it is as easy as starting a website, you are sorely mistaken.

 

There are a lot of less visible aspects to their service, everything from the back-end servers that handle content delivery, to the content distribution rights they have, to their pre-existing 14M user base. Those users contribute to the site with their reviews and also get back suggestions via the algorithms that analyze their rental and review histories. That's extremely beneficial when you have a huge library of content and want to promote usage of the service. Not only that, but they are also -ALREADY- paying users. You can't just replicate something like that with some start up website. It's similar to the intangibles that come from social networks that reach critical mass.

 

Plus, there are some benefits to all the content being under one roof by a party that isn't owned by movie studios. Hulu is a good example of this. It is owned by media companies but they fight with each other; resulting in content being removed prematurely and the users of the site suffering.

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What about 5 years from now? Can you predict how hard it will be to create a website like this? Do you know netflix will be dominant, then, 10 years from now? These uncertainties plus a high price with no real room for growth ( i mean netflix has been around for a long time now) makes me wonder why this company is worth 5 billion dollars. What do you think the replacement cost is for creating something like netflix? Certainly less than 5 billion!

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A few things:

 

I think it's a bad idea to short stocks period.  Pabrai and others say "100% upside, infinite downside", vs long ideas "100% downside, infinite upside". 

 

It's a really really *really* bad idea to short a strong company based on valuation.  For shorts you should go for optimisticly valued crumbling businesses with a catalyst that will bring them down.

 

Netflix has quite a few good things going for it.  Subscriber (recurring) revenue base with low attrition rates.  Reed Hastings as CEO (very techie background).  Ex-postmaster general on the board, to help with massive distribution of DVDs.  Technology in place to efficiently order and route DVDs to people all throughout the US in optimized manner.  Relationships with studios to use DVD content, and also now for streaming content.  Very strong technical leadership and background.  Really Netflix is a technology company in a content field.  I'm not saying they aren't expensive..  But they are probably an acquisition target at some stage.  They destroyed Blockbuster, and fended off both Walmart and Amazon from their turf.  That should give you an idea of the quality of the company.  Not maybe companies beat on Walmart and Amazon.  As to where they can grow?  I don't know, but their recent deal with Akamai indicates that for international they are probably thinking streaming.

 

Anyway, I'm sure there are many, many *crappy* companies with sky high valuations and crushing debt.  Those would be much better candidates for a short...  Shorting great companies is just a bad bad idea, at any valuation...

 

IMO.

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Pabrai and others say "100% upside, infinite downside", vs long ideas "100% downside, infinite upside". 

 

I believe Pabrai just wants to keep his message simple for the interviews, and that he is fully aware that you can go short without infinite downside.  For example when Fairfax shorts the S&P500 they do not have infinite downside -- and Pabrai invests in Fairfax.  Fairfax hedges the short with call options.

 

 

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I'd be very careful with shorting Netflix:

 

- Netflix benefits from a huge network effect and might be on the verge of winning the digital video battle. Back a year or 18 months ago, it was just an internet DVD rental business that had revolutionized the industry with its flat fee model (no late fees - that killed BlockBuster). But it was just a "time business" as everybody knew that the next support for movies would be digital. Nobody knows yet who is going to win that digital battle but it seems that Netflix is moving ahead of the pack. Their recent metrics showed that more and more subscribers are using their streaming service (could be done with an Xbox or with a Wee now). I personally canceled part of my Comcast subscription and reactivated Netflix a year ago so that we could us the streaming. I'm saving $50+ a month and my kids like the service better. I see lots of anecdotal evidence that I'm not the only person making that move. So, in a work, it's a business that has a huge momentum. I'd advise you to read the "gorilla game"; it discusses in depth the impact the network effect can have on a stock;

 

- While I also believe the stock is overvalued, we are - again - in a world of zero interest rates. See what happened in 1996-1999 or in 2003-2007... There were lots of overvalued stocks that kept going up for a long time. How would you have done if you had shorted amzn at $50 in 1999? You'd have had to wait 2 years before it went back to that level... Jeremy Gratham, in his latest letter, also thinks that there is a significant probability that the markets keep going up in the next 18 months...

 

- Remember Keynes: "Markets can remain irrational longer than you can stay solvent."

 

Eric

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  • 9 months later...

As I continue to watch NFLX rise and I have been thinking about how to play it's eventual fall in price. I'm thinking about using LEAPs, but am not entirely sure how to set it up with my brokerage firm. Any thoughts on how to play this?

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