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The Netflix Cash Crunch That Wasn't

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Netflix (Nasdaq: NFLX  ) shares plunged as much as 7.5% overnight. The company is raising $400 million of fresh capital, half in stock sales and half in zero-coupon notes.

Bearish analysts immediately pounced on the deal. Wedbush Morgan worries about "deteriorating performance" causing damage to Netflix's liquidity. The firm lowered its Netflix price target to $45 per share. Caris looks at the two-part deal and sees evidence that "subscriber growth, and hence revenue growth, were not strong enough in either the current quarter, nor in the first half of F2012 to cover" the cost of ambitious content deals.

The capital deals were announced in dry-as-sawdust SEC filings, so I reached out to Netflix spokesman Steve Swasey for some color commentary. "We don't think we need the money, but it's nice to have more money than you need," he said. There are no immediate plans to put the money to work, and no cash-crunching liquidity crisis. And the capital comes from "two long-term-oriented partners," T. Rowe Price (Nasdaq: TROW  ) and Technology Crossover Ventures, who see value in grabbing million-unit chunks of Netflix stock at today's prices.

In fact, the notes that TCV are buying only convert into shares at $85.50, which is a premium to current share prices. The venture capitalist is betting that the stock will rise above that level. Price is buying shares at $70 a pop, hoping to unload them at higher prices. If that happens, today's dilution might be forgiven. After all, share prices would obviously be up again.

Good riddance to buybacks
That said, it's not all gumdrops and lemonade. If the convertible bonds all get turned into shares, the combined deal adds about 5 million new shares to the total share count, or 10% dilution. And in effect, all of the money eventually comes out of the pockets of us common shareholders. Who else would buy the new shares down the road to make the whole transaction worth TCV's and Price's while?

Not the most shareholder-friendly policy, folks. Netflix could have grabbed about the same amount of extra cash by simply not buying back shares over the last two years. So the company bought high and sells low. Oh, dear.

But I'm flogging a deceased pony here. The buyback policy is gone at long last, and I hope it ain't coming back until the high-growth era has passed.

You say it did already? Sorry, but one customer-losing quarter does not make a trend. If so, Netflix would have stopped growing when Blockbuster launched its unsustainable Total Access assault way back in 2006. Netflix lost some customers then, but it gained them all back and then some as Blockbuster's strategy backfired.

This time, the subscriber losses are Netflix's own doing but just as short-term in nature. In the latest earnings report, CEO Reed Hastings predicted that defections would slow down in November and turn into another round of heady growth in December. The prospectus filing for the stock sale confirms that Netflix is on track to do exactly that.

What's good for one goose may be wrong for another
In my eyes, raising debt to support outsized growth is a perfectly valid strategy. If you disagree, feel free to sell your Netflix shares and buy some Buffalo Wild Wings (Nasdaq: BWLD  ) instead. The sports-bar chain has chosen to grow at more modest speeds, leaving long-term debt as zero and stock sales very modest indeed.

This works in a mature industry like quick-serve restaurants, and I do love B-Dub's low-risk growth strategy. But Netflix is too busy defining a new industry to slow down and look at the scenery. Stop growing for too long, and Blockbuster could wrest back control of the new video-rental market with capital from corporate parent DISH Network (Nasdaq: DISH  ) . Or perhaps Coinstar (Nasdaq: CSTR  ) would have time to roll out a tremendous Redbox-branded service while Netflix isn't shouting its brand from the rooftops. Apple (Nasdaq: AAPL  ) is always a credible threat in any digital-media market, and maybe even Comcast (Nasdaq: CMCSA  ) could figure out how to beat Netflix at its own game.

This is why high long-term growth is so important for Netflix. By hook, crook, or somewhat icky capital grabs, the company must keep growing until the gold-rush land grab is done. Only then can Netflix afford to slow down, collect profits, and buy back shares.

That time is still years away, and that's why I'm OK with the company's raising capital today. Netflix remains a screaming buy.

Digital video will help networking stocks, too. The Fool's top analysts sat down to compile a report on the best stock for 2011 and came up with an infrastructure play you've probably never heard of. Yet this company rides the rising video traffic just as directly as Netflix itself. The report is totally free and has been updated to keep up with the changing times. Get your copy right now -- it's free for Fools.

Fool contributor Anders Bylund owns shares of Netflix but holds no other position in any of the companies mentioned. The Motley Fool owns shares of Apple, Buffalo Wild Wings, and T. Rowe Price. Motley Fool newsletter services have recommended buying shares of Apple, Coinstar, Buffalo Wild Wings, and Netflix, and have also recommended creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Check out Anders' holdings and bio, or follow him on Twitter and Google+. We have a disclosure policy.

Read/Post Comments (7) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 23, 2011, at 3:55 AM, ikkyu2 wrote:

    No moat.

  • Report this Comment On November 23, 2011, at 4:13 AM, bankruptcom wrote:

    Who is going to implode first (NFLX again) or EZ or XMAS ?

  • Report this Comment On November 23, 2011, at 9:44 AM, TMFZahrim wrote:

    @ikkyu2, Netflix has as much of a moat as Apple. There's a ton of phones as good as the iPhone, laptops beating Macbooks, better media players than the iPod, but Apple has established a brand that people equate with leading phones, computers, music players, and so on. Netflix has done the same in movie rentals. Same story, different market.


  • Report this Comment On November 23, 2011, at 10:54 AM, chadhenage13 wrote:

    @TMFZahrim sorry but not buying that argument. AAPL has developed products that redefined a space for instance who made something "as good as the iPhone" there was no such thing. I was a PC user until about 3 years ago when I first tried out an iPhone which then led me to want to try out a MacBook, which led to choosing a Mac Mini and an iPad currently.

    NFLX has a good moat in the form of millions of satisfied users and they are already in many devices. However, NFLX has made some terrible decisions like a 60% price increase, Qwikster, and now the revelation that they essentially bought back their shares at about $220 and now they are issuing new shares at $70. There is no way that NFLX doesn't need the cash and just raised it just because. While NFLX is much cheaper now then a few months back I can't see how it's a screaming buy based on losing money all of next year when just a few weeks ago it was only going to lose money for the first quarter. How do you come up with a fair value for a company with no earnings?

  • Report this Comment On November 23, 2011, at 11:13 AM, TheDumbMoney wrote:


    I'm not buying your moat argument either. At the end of the day, moat is about economic goodwill. And at the end of the day, economic goodwill is about the ability to raise prices and still sell the same amount of product. It comes from multiple sources: addiction (MO), coolness (AAPL), ubiquity (KO), near-monopoly (MSFT), continual cost-leadership (WMT -- which actually often beats Amazon, even on online shopping AND with having to pay for shipping, b/c WMT is an absolute beast); and technological advantage (GOOG, whose searches are simply the best).

    Netflix concretely demonstrated this year that when it raised prices it could not sell the same amount of product. (The counter-argument is that it raised prices too much.) I would assign it a very narrow moat based on a first-mover advantage. It has no technology that can't be copied, no inherent price advantage, it is not addictive, etc. This isn't to say that NFLX won't do well. I don't think this is the end for NFLX; in fact I think it's a buy around $55-$60/share (which I think it will see within the next four months). I just think it has done some incredibly stupid things in the last year, which have, in addition to harming short-term results, exposed some fundamental flaws in its business model and claim to possession of a moat.



  • Report this Comment On November 23, 2011, at 2:27 PM, mjtri wrote:

    Buy high, sell low. As a minimum, I hope that Hasting's receives no bonus this year and his salary should be no more than $1. At least I got lucky and sold Netflix high and recently bought BWLD.

  • Report this Comment On November 25, 2011, at 6:54 PM, jimmach123 wrote:

    Dumberthanafool - I agree with all you write, but think you are high on the price. They are going to be negative for the next 12-15 months in earnings, and there is just no way to price it right now without knowing how these next couple quarters will go.

    I am amazed the author thinks this loss of subs is only a short-term thing and that growth will restart. Seriously? Then why is the company, in a matter of only 4 weeks, now saying all of 2012 will be negative for earnings when it was $1.50 at the end of October? Oh, I know the bull argument - "they are expanding and growing internationally." Well, what changed in the last 4 weeks that is costing so much that was not factored into the plan? In addition, how has international expansion gone so far for them?

    The reality - Subs are still leaving and growth is stagnant - the moat has caved. NFLX is no longer defining this industry - competition has come in and is assisting with pressure in their bad decisions which have created an unsustainable business model. Brand loyalty is gone and the streaming business, unless they can drastically improve overall content, will be an utter failure.

    This is from a customer since 2003 - just downgraded my own sub - streaming is a joke and waste with their current content.

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