Netflix (NFLX +1.15%) is on a tear this year. As of this writing, shares of the online streaming provider are up approximately 65%, versus the greater S&P 500's 4% advance. The largest catalyst for the company's strong 2018 showing was its fourth-quarter earnings, its first report following its November price increase. Unlike prior price increases, which resulted in dampened subscriber additions, Netflix reported record subscriber additions in the quarter, pointing to increased price inelasticity from their sticky content library.
Not everybody is buying into the rally, however. Recently, shares of the company fell under pressure from noted short seller Andrew Left. Left's firm, Citron Research, tweeted that the company should get shorted back to $300, prompting a 3.5% sell-off. In an interview with CNBC, Left faulted Netflix for not having a moat, saying it will have to compete with deep-pocketed competitors.
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The long and short of Andrew Left
Left's sterling record shorting companies was recently slightly tarnished. After making a legendary call on Valeant Pharmaceuticals with deep research and thorough examples of possible fraudulent accounting, his newer short calls have been hit-or-miss.
Notable misses include a bold call on Tesla in early 2016, assigning a price target of $100 per share, which was half of its then-current price. After a short-term sell-off, Tesla shares continued to move higher -- and it now trades at approximately $350 per share.
His October short of Shopify has also gone particularly poorly for long-term shorts. Despite a 20% drop in the days following Left's short announcement, with shares closing as low as $90, it's been mostly a straight line upward to its current price of approximately $150 per share. Ubiquiti Networks, exposed as a "complete fraud" by Citron at $55 per share in September, is now $70 per share.
Left and Citron have had some recent successes too, however. Their November Roku short recommendation has been a winner, as the stock is approximately 15%-20% below the pre-short price.
Think thrice before you follow Left into this short
For long-term investors, there are three reasons why I feel you'd be a fool (lowercase f) to follow Left into a Netflix short. First, there's an obvious mismatch between the timeframe of Left's negative catalyst -- unsustainable long-term content spend -- and his short.
If Left feels content spend is unsustainable, then it's likely the price of the stock will fall more than 10% as users abandon the service. However, Netflix has already committed and budgeted $7.5 to $8 billion for content this year, so it's unlikely a cut will occur soon.
Second, this seems like a momentum-fatigue short. As previously stated, Netflix has increased a mind-boggling 65% year-to-date, including Left's short attack, and those who believe in mean reversion think the stock will give some of those gains back. Citron's tweet hints at it being a mean-reversion-based short, as the firm notes the fact Netflix's market cap increased $17 billion in a week.
Due to the asymmetric nature of gains and losses, a short position is inherently more risky than a long position. As such, I'd caution against momentum-based shorting for long-term investors, especially for a meager possible 10% gain.
The third reason is I'd disagree with Left's opinion that Netflix lacks a moat is that the company just increased prices and still had record subscriber adds. How? Because of its original content -- that's Netflix's moat.
When does Citron close positions?
Short sellers are often a despised lot, and that's unfortunate. The stock market is often too biased in favor of bullish opinions, and can often overlook risk factors, fraud, and misallocated capital and investments. Short sellers serve an important function by simply maintaining a skeptical nature and putting their money on the line. They are an important part of healthy, well-functioning markets, and should be encouraged.
Where short-sellers enter an ethically gray area is shorting a stock under the premise that their short announcement alone could be the short-term catalyst that will drive the stock down. To be clear, I'm not saying Citron is doing this. However, it's worth looking at the differences in veracity between the firm's initial short thesis and its less forthcoming nature when it closes positions.
That said, it is my opinion this is the wrong short at the wrong time with the wrong thesis. You're more likely to make money going long on Netflix now than taking a short-term short.
