This Was Netflix's Biggest Blunder

Today's obviously a good day for Netflix (Nasdaq: NFLX  ) investors.

Shares of the video service provider are soaring after a blowout quarter. Netflix easily topped Wall Street's watered-down projections.

The sky isn't falling on Netflix, after all. The total unique global count of couch potatoes now stands at a record 26.2 million subscribers.

It's against this euphoric backdrop with Netflix's stock racing back into the triple digits that I want to revisit the flick flicker's biggest mistake.

It wasn't Qwikster. That brand will go down in the annals of business history as one of its greatest punch lines, but at least Netflix had the intelligence to nix it three weeks after it was announced. Not a single subscriber had to move to the distinct website for DVD rentals.

Netflix's biggest mistake wasn't the summertime price hike either. It may have been what alienated many of its customers during the third quarter, but it was necessary. Studios weren't going to dilute their content by continuing to give it away as part of a freebie given to DVD subscribers. The $7.99-a-month price point works, and now Netflix can say that it has a whopping 23.5 million premium streaming subscribers around the world.

So where did Netflix blow it?

Well, how about Nov. 21, when Netflix announced the completion of $400 million in financing through a stock sale and a convertible offering?

It was on that day when Netflix agreed to hand over 2.86 million freshly minted shares at $70 apiece to mutual fund giant T. Rowe Price (Nasdaq: TROW  ) . The move helped raise $200 million. Another $200 million was drummed up through the sale of zero-coupon convertible notes with an initial conversion price of roughly $85.80 a share.

The move was ridiculed at the time, and rightfully so. The same company that had spent roughly $200 million through the first nine months of 2011 buying back less than a million shares for $200 million at an average price of nearly $222 a share was now diluting investors to the tune of 5 million shares to raise $400 million!

Buy high, sell low?

However, now that the stock has soared roughly 75% since bottoming out around the time that the secondary offerings were completed, it's clear that Netflix picked the worst possible time to print new shares -- just as it picked the worst possible time earlier in the year to retire some shares.

Today's a day for cheering, but a little jeering wouldn't hurt.

Motley Fool co-founder David Gardner has been a fan of Netflix as a disruptor for nearly a decade, but there's a new Rule-Breaking mutlibagger that he's getting excited about these days. Learn more in a free report that you can check out now.

Longtime Fool contributor Rick Munarriz has been a Netflix subscriber and shareholder since 2002. He does not own shares in any of the other stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

The Motley Fool owns shares of T. Rowe Price Group. Motley Fool newsletter services have recommended buying shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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 (3) | Recommend This Article (5)

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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 January 26, 2012, at 11:30 AM, rhealth wrote:

    Ok, this is the 3rd "Netflix isn't that great" article today and it's starting to smell like sour grapes. Netflix made a bold move and it didn't work out. they rallied their forces, expanded overseas and pushed for new content and erased an enormous portion of their losses in THREE WEEKS!

    I'm not picking on you Rick, you're just the strike three today. When everyone else was saying it'll be years to recover, no moat, blah blah, I was buying shares and now I'm up 40%. Will I keep it? probably not all of it, but my faith in Netflix was tested, not shaken. I believe in the company long term and am glad I took the risk to load up on shares when everyone else was hating.

  • Report this Comment On January 26, 2012, at 11:42 AM, TMFBreakerRick wrote:

    rhealth, as a longtime shareholder and believer I'm right there with you.

    I'm surprised that you're seeing so many "Netflix isn't that great" on a day when the stock popped higher. I'm certainly impressed by the report, and have another article about exactly that.

    I just needed to get this off my chest. Netflix didn't just buy back its shares at the worst possible time. In retrospect, it sold new equity at the worst possible time as well.

  • Report this Comment On January 26, 2012, at 12:19 PM, VoiceintheCrowd wrote:

    I think the point about shareholder dilution is valid and worth mentioning because it tends to get lost in the more headline- (and punchline-) friendly "Qwikster" saga. However, I still think calling it "Netflix' biggest blunder" might be a little bit hyperbolic. If nothing else, that equity sale might well not have been necessary (or it would have been for a fewer number of shares at a higher price) had it not been for the Qwikster debacle and the temporary jitters over the price increase.

    In addition, while shareholder-unfriendly actions by management (including any measures involving dilution) are always worth taking into account, the Foolish emphasis should be more on the quality of the underlying business (including its management). Notwithstanding the fact that we have to share space at the party with T Rowe Price who got a cheap invitation, it's still a pretty good party.

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