Whitney the Netflix Waffler

February 14, 2011 at 3:18 am Leave a comment

Source: Photobucket

No, I am not talking about Meredith Whitney (see Cloudy Crystal Ball), but rather Whitney Tilson, a well-known value and hedge fund manager at T2 Partners LLC. Less than eight weeks ago, Tilson boldly and brashly exclaimed why Netflix Inc. (NFLX) was an “exceptional short” and provided reasons to the world on why Netflix was his largest short position (read Tilson’s previous post). Fifty-five days later, Mr. Tilson evidently was overtaken by a waffle craving and decided to throw in the towel by covering his Netflix short position.

What Changed in Seven and Half Weeks?

Margin Thesis Compromised: Tilson explains, “The company reported a very strong quarter that weakened key pillars of our investment thesis, especially as it relates to margins.” Really? Netflix has grown revenues for nine straight years since its IPO (Initial Public Offering) in 2002, and growth has even accelerated for two whole years (as Netflix has shifted to streaming content over snail-mail), and just in Q4 he became surprised by this multi-year trend? The Q4 growth caught Tilson off-guard, but I guess Tilson wasn’t surprised by the 7.5 million subscribers Netflix added in 2009 and first three quarters of 2010. Never mind the five consecutive years of operating margin expansion either (source: ADVFN), nor the stealthy share price move from $30 to around $225. Apparently Tilson needed the recently reported Q4 financial results to hit him over the head.

Survey Provides Earth-Shattering Results: Tilson conducted an exhaustive study of “more than 500 Netflix subscribers, that showed significantly higher satisfaction with and usage of Netflix’s streaming service than we anticipated.” Come on…Netflix has more than 20 million subscribers, and you are telling me that a questionnaire of 500 subscribers (0.0025%) is representative. Even if these results are a cornerstone of Tilson’s modified thesis, I wonder also why the survey wasn’t taken before Netflix became Tilson’s largest negative short position. In addition, I can’t say it’s much of a revelation that Tilson found “significantly higher satisfaction” among paying subscribers. That’s like me going to a Justin Bieber concert and polling J-Beeb fans whether they like his music – I’ll go out on a limb and say paying customers will generally have a positive bias in their responses.

Feedback Tilts the Scales: Tilson received a “great deal of feedback, including an open letter from Netflix’s CEO, Reed Hastings.” If I received a penny for every time I heard a CEO speak positively about their company, I would be retired on a private island drinking umbrella drinks all day. Honestly, what does Tilson expect Hastings to say, “You know Whitney, you really hit the nail on the head with your analysis…I think you’re right and you should short our stock.”

Some other inconsistencies I’m still trying to figure out in Tilson’s new waffle thesis:

Valuation Head Scratcher: Also frustrating in Tilson’s 180 degree switch is his apparent incongruous treatment of valuation. In his initial bearish piece, Tilson explains how outrageously priced Netflix share are at 63.1x the high 2010 consensus estimate, but somehow a current 75.0x multiple (~20% richer) is reason enough for Tilson to blow out his short.

Competition: Although Tilson went from 100% short Netflix to 0% short Netflix, there does not appear to be any new information regarding Netflix’s competitive dynamics from the Q4 financial release to change his view. Here is what he said in his article eight weeks ago:

“Netflix’s brand and number of customers pale in comparison to its new, direct competitors like Apple (iTunes), Google (GOOG) (YouTube), Amazon.com (AMZN) (Amazon Video on Demand), Disney (DIS) and News Corp. (NWS) (part ownership of Hulu), Time Warner (TWX, TWC) (cable, HBO, etc.), Comcast (CMCSA) (cable, NBC Universal, part ownership of Hulu), and Coinstar’s Redbox (CSTR) (30,000 kiosks renting DVDs for $1/night and email addresses for 21 million customers).”

 

Little is said in his short covering note, other than these negative dynamics still exist and help explain why he is not long the stock.

Gently Under the Bus

Whitney Tilson was “against Netflix before he was for it,” a stance that could generate a tear of pride from fellow waffler John Kerry. However, I want to gently place Mr. Tilson under the bus with all my comments because his sudden strange reversal shouldn’t be blown out of proportion with respect to his  full body of work. As a matter of fact, I have favorably profiled Tilson in several of my previous articles (read Tilson on BP  and Tilson on Fat Lady Housing).

One would think given my profitable long position in Netflix that I would be congratulating Tilson for covering his short, but I must admit that I feel a little naked with fewer contrarians rooting against me. The herd is occasionally right, but the largest returns are made by not following the herd. Short interest was about 33% of the float (shares outstanding available for trading) mid-last month, and with the recent melt-up, my guess is that short percentage has shrunk with other short covering doubters. I haven’t decided how much, if any, profits I plan to lock-in with my Netflix positions, but as Tilson points out, they are not giving Netflix away for free.

Credit should also be given to Tilson for having the thickness of skin to openly flog himself and admit failure in such an open forum. I have been known to enjoy a waffle or two in my day as well (more often in the privacy of my own kitchen), and waffling on stocks can be preferable to loving stocks to the grave. Tilson has proven firsthand that eating waffles can be very expensive and detrimental to your profit waistline. By doing more homework on your stock consumption, your waffle eating should be spread further apart, making this habit not only cheaper, but also better for your long-term investment health.

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) at the time of publishing had no direct position in DIS, NWS/Hulu, TWX, TWC, CMCSA, and CSTR but SCM and some of its clients own certain exchange traded funds, NFLX, AAPL, AMZN, AAPL, and GOOG, but  did not own any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

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