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Netflix: Double-Costanza Time After the Most Predictable Collapse of 2011

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Netflix gave investors plenty of signs of impending doom; now there's no telling of how low earnings can go.

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The most incredible thing about Netflix (NFLX) isn't the fact that it's down over 70% from its July 13 high of $304.79.

No, what really makes this fallen star interesting is the fact that this collapse was 1,000% predictable.

As I've opined before, momentum stocks are built upon two things: hype, and earnings momentum. In other words, they do something interesting as a business, and they beat earnings estimates and raise guidance.

If a company can generate hype and deliver big earnings numbers consistently, then it can trade at 40 or 50 or 60 or 100 times earnings, no problem. Two prime examples would be Salesforce.com (CRM) and Chipotle (CMG).

On the flip side, that hype/earnings momentum combination makes for an awfully shaky foundation when the stuff hits the fan.

So with the educational fluff out of the way, let me take you through a timeline of the past five months, with Netflix's closing price from each date:

1. July 12 -- $291.27
Netflix announces price increases of as much as 60% for customers that subscribe to both its DVD-by-mail and streaming services. Customers start getting cranky. But hey, they gotta make money, right?

2. July 26 -- $266.91
The company reports a monster second quarter, but lousy Q3 guidance due to the price increases' impact on the subscriber count. Bizarrely, Netflix forecasts that it will hit $1 billion in revenue during Q4, a prediction that I considered to be completey ridiculous. Hope officially becomes a part of the Netflix case, as the company's overly bullish Q4 outlook sets Wall Street's expectations far too high.

3. September 15 -- $169.25
Netflix cuts its third-quarter subscriber guidance, making it clear that business was not bouncing back as expected -- another indication that the company was in the middle of a bad streak. This should have scared the living daylights out of anyone still bullish on the stock.

4. September 18 -- $155.19
Netflix announces plans to separate its DVD-by-mail service, which will be rebranded as "Qwikster." Every customer hates the fact that they will have to deal with two websites with separate billing.

5. October 10 -- $111.62
The company ditches the Qwikster idea amidst widespread criticism.

6. October 24 -- $85.00 (low in extended trading)
Netflix reports better-than-expected third-quarter revenues and earnings, but a lower-than-expected subscriber count and absolutely atrocious fourth-quarter guidance.

Now after looking at this timeline, can you come up with a more obvious collapse of a momentum stock? I'd have to go back to my own disastrous misadventure with Rackable Systems for something comparable!

Multiple guidance cuts, irrational product management leading to outraged customers -- Netflix really laid it all right out for us.

Watch for Shrinkage!
Headed into the quarter, Wall Street was expecting Netflix to earn $6.14 a share next year. That number will get aggressively chopped down tomorrow.

And it's not just the estimates getting cut -- it's double-Costanza time, where the earnings multiple feels the same shrinkage as the estimates.

Netflix lost over 800,000 subscribers in Q3. On the call, management said the subscriber count will be up slightly in Q4, but they haven't really been on the ball with properly setting expectations this year, have they? It wouldn't surprise me one bit to see another subscriber loss next quarter.

So what's the solution to the subscriber count issue? They can throw marketing dollars at the problem, but that will further impact margins.

They can do nothing, but that means customer additions slow.

What else? Netflix could cut prices, but that puts the loons in charge of the asylum, and it will never be able to raise prices again.

What Else Could Go Wrong?
There are other potential bad omens on the horizon. Amazon.com (AMZN) could decide to make a harder push with its Prime Instant Video service.

Plus, one of the most important revelations coming out of Steve Jobs' upcoming biography is that he dreamed of an Apple (AAPL) television -- a device that would no doubt plug right into the iOS/iTunes audio/video ecosystem.

So Mr. Comeau, Why Didn't You Short Netflix?
Because I'm an idiot, that's why.

P.S. I went bullish on Pandora Media (P) back on August 26. I'm backing away from that stance after taking a new look at the online-music landscape. It's become increasingly obvious to me that there are far too many online music services, and Spotify's cozy relationship with Facebook makes me a bit nervous.

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No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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