What Netflix's Hastings Did Wrong

At the beginning of the week, Reed Hastings, CEO of Netflix (Nasdaq: NFLX  ) , published a rebuttal to the short investment thesis previously published by Whitney Tilson, an act Tilson respected. That's generated quite a bit of comment, both supporting and not. Many think it was improper of Hastings to so spiritedly defend his company from what might be a short attack. It was beneath him, they say, and has even been compared to John Mackey, CEO of Whole Foods Market (Nasdaq: WFMI  ) , and his posts under the pseudonym "Rahodeb."

Here's what I think.

Just like the other?
First, I do not think it is comparable to the Rahodeb postings. Mackey pretended to be someone else and never disclosed that he was the CEO, so people could not properly put his comments into context. Hastings' letter, on the other hand, was signed with his own name, and he disclosed at the end that he was the CEO of Netflix. That puts an entirely different weighting on it. This was a one-time event (so far), not a long series of posts.

Second, it is not unheard of for a CEO to discuss his company, especially when he views his responses as defense against an attack. Patrick Byrne, CEO of Overstock.com (Nasdaq: OSTK  ) , is known for waging a war against naked short selling of the shares of Overstock (that is, borrowing shares to sell short that were not actually available to be borrowed). However, Hastings might not be so desirous of being lumped in with Byrne. Of course, Hastings' response to Tilson was a lot more polite than a lot of what Byrne has said in the past.

Improper!
Actually, I think any outrage comes down to a sense of propriety and what is considered proper behavior for a CEO. Let's consider this further.

Did Hastings discuss anything that has not been discussed before, by either himself and his management team or analysts of one stripe or another? I don't think so. The bull arguments have been well aired, so the perceived problem doesn't lie there.

Maybe it's the idea of talking up your company. A lot of comments I've read call him out for that. But consider that management teams routinely go and present their companies to analysts or investors at conferences, often sponsored by the big banks. In other words, management goes specifically to talk up their companies. So if Hastings did that in his response, it shouldn't be the problem; or if it is, that's a bit hypocritical.

All right, then … it has to be the fact that Hastings is attempting to correct a view held by an analyst, yes? Well, I'm not so sure. I've heard Netflix's management correct analysts on conference calls when they misunderstand something regarding Netflix. For instance, Hastings has said before that margins are controlled by management. That can certainly be viewed as an attempt to correct the popular belief that margins will contract as competition heats up. So correcting an analyst's misunderstanding shouldn't be the problem here. After all, nobody objected to it when it was done under other circumstances.

So what does that leave? Protecting the stock price, maybe, especially for his own gain. Oh, good one, and popular to boot. Everyone knows that short attacks are meant to drive the stock price down, something management is supposed to hate. Except this doesn't hold water either. Hastings has been exercising and selling options on a regular schedule for a long time, regardless of where the stock price is, up or down.

Shameful!
So what's his sin, then? Maybe it's telling the emperor that he has no clothes. That is, Netflix's management probably understands a great deal about the dynamics of their business, the level and types of competition out there, the workings of the Internet, and the consequences of various changes to it. With all that business knowledge, Hastings has told the bears, with Tilson probably the most famous, that their argument as laid out is flawed.

The emperor has no clothes. Announcing that is a big no-no, no matter who you are. Fie, Hastings, fie!

Want to read more about Netflix? Add it to My Watchlist, which will find all of our Foolish analysis on this stock.

Fool analyst Jim Mueller owns shares of Netflix and is rather pleased that Hastings spoke out as he did. He works for the Stock Advisor newsletter service. Netflix and Whole Foods are Motley Fool Stock Advisor selections. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (9)

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  • Report this Comment On December 23, 2010, at 10:55 PM, frankz00 wrote:

    Nope. Some of these ANALysts need to start getting called on the nonsense they spout out. He did the right thing.

  • Report this Comment On December 23, 2010, at 11:01 PM, afavorsky wrote:

    Well, let us see here, what is my problem.

    My problem number is that I prefer ceos of companies I hold to be focused on business and prove their points with results and not with chasing other people and replying to their analyses. Have you ever heard Jobs engage in such dialog? Google? Why not, what do you think?

    My problem number two is that if I were nflx ceo, I'd be wary of defending PE of 70. That is an awful lot of PE even for the brightest future. Does he think his company is priceless?

    My third, and most important problem is that I strongly doubt there isn't more to the story. Too many things happen all at once. Cfo leaves, ceo engages in unusual public debates with short sellers. My theory is that nflx is gearing up for a secondary. As they enter likely competition with apple, amazon and google, they need cash. Which they do not have. They'd be inept if they did not try to raise some using their current fame. This is ok, I would want to do just that if I were in nflx management. But pumping an already frothy price to get more from the secondary is not ok. It will actually hurt some shareholders who get in just before secondary is announced. Let us wait and see.

  • Report this Comment On December 24, 2010, at 4:22 PM, TMFGebinr wrote:

    Hi frankz00,

    I must not have used a broad enough brush with my sarcasm in the article. If you read the disclosure statement at the end, you'll see that I agree with you that what Hastings did was not a bad thing at all.

    Thanks for reading!

    Cheers,

    Jim

  • Report this Comment On December 25, 2010, at 6:41 AM, vanyah wrote:

    Was it proper for Tilson to launch a Public Relations campaign to promote his own Short Position?

  • Report this Comment On December 30, 2010, at 10:01 AM, BioBat wrote:

    aforovsky,

    I agree to a point that they probably will compete with Apple, Google, and Amazon at some point but let's not be hasty. The bear argument has been that any of these guys could just throw money at the streaming scene and destroy NFLX overnight. That's simply not true.

    Amazon has been trying to launch a comparable subscription service for months and even had a target roll out date of the 2010 holiday season. I'm sure you've seen it (sarcastic eyeroll).

    GoogleTV was supposed to be a NFLX killer but they've been nailed again and again by the content creators who are in no hurry to collaborate with the giant (even though the redistributed 'free' broadcasts generate Ad revenue).

    These things alone should tell you how difficult it is for these companies to just jump into the fray and do what NFLX does in a short time frame.

    No doubt that given enough time they can catch up to where NFLX is now but can they catch up to where NFLX will be 6 months or a year from now?

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