Saturday, October 1, 2011

Research: NFLX

NFLX has a wonderful and working business model. However, it is under terrible management. It perpetuates a scam I'd like to call the stock repurchase scam. The intention of this scam is to maintain a constant or slightly declining number of outstanding shares.

In its early days, NFLX had issued many stock options to employees. This is often necessary to entice employees to take lower salaries in a infant company that may go bust. Stock repurchases are supposed to be a way of returning money to shareholders by increasing each shareholder's percentage stake of the company's earnings. This is supposed to be done when the stock price is low.

What NFLX, as well as many other companies do, is use stock repurchases to HIDE necessary dilution as employees exercise their options. Management purposely overpays for stock repurchases for the sake of maintaining the number of outstanding shares. This artificially props up the earnings per share. Money wasted on overpriced stock repurchases do not show up as an expense on the income statement. As a result, NFLX, as well as many companies, can show positive profits and positive operating cash flow, with a lagging shareholder equity, all at the same time.

What NFLX SHOULD have done was to allow the stock to get diluted. This will equate to a lower earnings per share, but it's far less damaging than overpaying for repurchases.

NFLX's 10K shows that they spent 51.4M repurchasing 216K shares for an average price of $238 between Apr 1st and Jun 30 2011. With a price drop from 238 to its current 129 per share, NFLX had wasted about 24M in shareholder equity through that quarter alone. It's literally money thrown out the window.

I feel the fair value of NFLX is around 45-55 per share as of now. Until it comes down to around 60, I don't see a point it researching this any further.


  1. Were you thinking about trading NFLX at some point?

  2. No not especially, I feel far too uneducated to invest in individual shares so I just put a tiny amount of money in some funds (I know I know). Enjoy your blog though!

  3. Thanks! Don't worry, there's no shame in putting money into funds. It's much more respectable to acknowledge current limitations than to act foolishly. Feel free to ask me to elaborate on topics that you find interesting.