7 Reasons Netflix Could Be an Attractive Stock to Short

Is it time to short Netflix (NASDAQ:NFLX)? Whitney Tilson covered his Netflix short. Why, then would we want to short it?

Yoni Jacobs, Executive Director and Portfolio Manager for Chart Prophet Capital, argues that it may be time to do so. He lists seven main reasons why it may be time to short Netflix:

  1. Valuation: Netflix trades at a P/E ratio of almost 80, which is unsustainable over the long term.  Either its earnings have to increase and its stock stay essentially flat, or its earnings have to stay essentially flat and its stock price has to decrease, in order for its P/E ratio to revert to long-term market averages.
  2. Transitioning Business Model and Competition: Netflix is moving away from its traditional model of mailing DVDs to subscribers and towards a streaming business model.  While this greatly enhances the ability of the company to offer content to subscribers when they want it, rather than forcing them to depend upon the vagaries of the US postal system, it also exposes Netflix to larger, well-capitalized competitors who can afford to pay higher licensing fees for premium content.  Competitors such as Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG), and Disney (NYSE:DIS) (among, presumably, more competitors to come) are all much larger companies, with much larger balance sheets with which to finance content licensing fees.
  3. Streaming Library is Weak: Netflix’s model of offering bargain-basement $10 per month subscription fees for streaming content is a great benefit for consumers, but, as with everything, each benefit has a cost.  In this case, it is a weak library as compared to that offered by competitors, especially Apple.  Most popular movies are not available to rent via Netflix, and it is a valid question whether Netflix can continue to get away with not offering the most popular content via its service.
  4. CFO Resigns Unexpectedly: Barry McCarthy, Netflix’s former Chief Financial Officer, resigned in December 2010.  The resignation of a company’s CFO often does not portend good news.  The company cast his resignation in the following terms, quoting its CEO, Reed Hastings: “At the same time, we offer both great gratitude and sincere best wishes to Barry. Over the last few years, Barry has balanced his affection for Netflix–and the excitement all of us have felt by the tremendous growth of the company–with his personal desire for broader professional opportunities. Barry concluded that now is the right time to seek out those opportunities, and we will be cheering for him.”  Making reference to vague “opportunities” does not sound like a company with nothing to hide.
  5. Heavy Insider Selling: Both CEO Reed Hastings and former CFO Barry McCarthy have engaged in insider sales recently.
  6. Whitney Tilson Gives Up: This could be construed as being the point where the bearish bet on the stock may pan out for shorts.
  7. Technicals: Analysts have seen indications that the end is nigh.  Quoting Jacobs: “After seeing a tremendous rally backed by very high volume since August 2010, Netflix’s meteoric rise may now be unsustainable. Though the technicals visible in price levels still don’t point to a NFLX correction, the candlestick patterns do.”

Is Your Portfolio Maximizing its Potential? Get winning investment ideas with our acclaimed Wall St. Cheat Sheet Premium newsletter >>