Should Netflix Shareholders Hope for a Buyout?

Netflix (NASDAQ:NFLX) must be the stock from Hell for buy and hold investors. After hitting all-time highs above $300 in July 2011, shares plummeted like a roller coaster to finish the year at $70. The stock price rebounded to almost $130 earlier this year, to only suffer another dramatic drop-off. Shares recently showed signs of stabilization, but that ended after the latest earnings report. At this point, rumors and speculation may be the best hope for shareholders to exit this ride safely.

Before Netflix announced its third quarter financial results, shares were relatively flat on the year. The movie subscription service beat Wall Street’s estimate on earnings, but the devil in the details sent shares tumbling. Netflix added 1.16 million net new domestic subscribers in the September ended quarter, below analysts’ estimates of 1.43 million. In March, Netflix CEO Reed Hastings said that the company would add 7 million U.S. customers this year in order to reboot the company’s lagging growth in the United States. To reach that goal, the company needed to add approximately 1.8 million subscribers in the third quarter.

Although competitors such as (NASDAQ:AMZN), Coinstar (NASDAQ:CSTR) and Youtube (NASDAQ:GOOG) continue to expand their video offerings, Netflix blames the disappointing subscriber growth on poor forecasting. Hastings explains on the conference call, “I think we’re feeling our way along as the streaming market grows, and we miss-predicted, but I would call that more of a forecasting error than anything else. When we think about growing 5 million net additions in this year, if we had predicted 5 million, I think we’d all be feeling good, that that’s great growth. So we own it in terms of a bad forecast.”

The third quarter figures and excuses did not sit well with shareholders. After the results, shares of Netflix dropped 12 percent. However, shares have managed to recover all of the losses in less than a week a rumor hit trading desks and scared short-sellers. According to financial media outlet Benzinga, Microsoft (NASDAQ:MSFT) is still interested in acquiring Netflix. Over the past year, Microsoft, Apple (NASDAQ:AAPL) and other companies have been involved with Netflix buyout rumors. The latest speculation was enough to send Netflix shares surging 13 percent on Friday. Neither company has confirmed the rumors, but Hastings did recently announce that he would be stepping down from Microsoft’s board of directors in November, potentially removing any conflicts of interest that a buyout may bring.

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Investors who are tired of having their stomach turned over by Netflix’s dismal financial results and rumors should strongly consider taking the recent bounce in shares as an opportunity to exit this treacherous ride. Shareholders can certainly hope for an acquisition to take place, given its $4 billion market cap, but hope is never a good investing strategy. Netflix is also prone to more violent swings in the future since it is one of the most heavily shorted names in the S&P 500.

Going forward, Netflix lowered its domestic growth outlook for the full year to 4.73-5.43 million subscribers, well below the original 7 million estimate. The company also has a notable amount of obligations on its books, as seen in the chart below.

Total streaming commitments at the end of the third quarter came in at $5 billion, with $2.1 billion due within the next 12 months. Content licenses and related obligations are a major cost to Netflix’s revenues. Even more worrisome, the company states, “And, as we point out each time we reference obligations, the $5 billion represents the known minimum obligation amounts, but does not include obligations that we cannot quantify but could be significant.”