As the saying goes, stocks can stay irrational longer than an investor can stay solvent. Shorting stocks on valuation is a mug’s game, a fool’s folly. Traders found this out the hard way leading up to the tech bubble in 2000. Valuations were extremely stretched as the circumference of the bubble grew larger and larger. Fundamentally, there was no way for those “high flyers” to grow into their valuations in any reasonable period of time. It was true for AMZN then and every other high flyer including CMGI (remember them) and even CSCO. Eventually all these stock prices came back to earth but unless one was able to pick the exact inflection point when sanity overtook exuberance, it was a very expensive trade. But those who waited to put on a short until the first hiss of air as the bubbles popped, made a fortune on their shorts and never had to take an angry margin call from their broker. Thus the CMGI short was a much better trade at $100 on the way down from $160 than on the way up.
I am not suggesting that NFLX is another bubble company but rather a bubble stock. In fact, it is a good company with very good management but once a stock reaches such ridiculous valuations, where the expectation is for uninterrupted hyper-growth that has never been seen before, the question must then be asked: am I investing in a company or a stock? NFLX long ago morphed into a stock investment, its valuation driven more by momentum than by fundamentals. It faces challenges such as content costs, growing competitive threats, a struggling consumer, new pricing plans which have turned universal love into negative sentiment and new data pricing plans by wireless carriers which should inhibit usage. The post bubble decline in AMZN’s stock price from its peak was a lot swifter than its recovery, all the while the core operations of the company remained on a positive slope. I don’t know how many stayed with AMZN during that downdraft but I would guess relatively few. Waiting for the turn in the stock price, foregoing the initial move, reduced the stress and made the risk/reward profile more attractive.
The NFLX bubble has sprung yet another leak, the hissing of the air escaping growing louder and more frequent. The story is developing more holes than the proverbial piece of Swiss cheese. First, the earnings miss last quarter, then the long tail investment in LatAm and new pricing plans and last week the Titanic-iceberg moment when the stock really took on water as Starz broke off negotiations. Now, here we are with the very core of the business, subscriber growth, not meeting expectations. In short, NFLX is a broken growth stock and it is too soon to start picking the bottom; still too expensive for GARP and Value, and the continuing degradation in fundamentals keeping Growth investors at bay.
Despite the significant decline in its share price, NFLX is a less risky short now than it was at $250 since the fundamentals have clearly reversed. They will continue to lose content as Time Warner CEO Jeff Bewkes made abundantly clear months ago when he talked about the mismatch in what NFLX pays them for their content versus the value they derive. Like John Malone, Bewkes will draw a hard line in negotiations and is prepared to walk away. I may eventually invest in the company on the long side, but only when it returns to being an investment in a “company” with an attractive valuation. With the valuation still in the stratosphere, we are a long way off from that point. I’ll reassess at par. I would use puts to express the short to guard against some cash rich tech CEO seeking growth through a dilutive acquisition.
Disclosure: Weiss has a put position in NFLX.