Whitney Tilson: What are you thinking? My Netflix analysis

Whitney Tilson's Netflix story is an interesting one. He wrote an excellent article about shorting Netflix when it was at $170.

http://seekingalpha.com/article/242320-whitney-tilson-why-we-re-short-netflix

He covered the short at about $200 after being persuaded by Reed Hastings (NFLX CEO) to do it.

The stock went to $300 then crashed. Damn. Heartbreaking.

Now it gets interesting:
Tilson then bought the stock at $85 or so. Ok. His quote that struck me was "I hope it gets cheaper so we can add to [our position]."

http://dealbreaker.com/2011/10/whitney-tilson-t2-partners-nailed-its-netflix-short-except-for-the-fact-that-it-didnt/

Wait - what?! Why would you ever want a stock you buy to go down? Are you saying that in the spectrum of thousands of publicly traded U.S. companies - and a larger plethora of international ones - you can't find a single investment opportunity that you like, so you want your current positions to go down??? That makes no sense.  Diversify, Tilson. If a stock goes up, sell it and buy another cheap one. Wait, it gets worse -

So it's January and the stock is trading in the $100 range now, and Tilson has made about 20% on his long position. In a recent interview, he said that "he is in Netflix for the long haul." Ok. So what is your price target?

Here is how investing works in my mind. You don't have to nail your analysis. You don't have to be a brilliant mathematician. All you have to do is find stocks that are so cheap (or short ones that are so expensive) that your probability of profit is high. In other words, you find a stock that you think is worth $180 and you buy it at $100, you don't buy a stock you think is worth $120 for $100 because there is not enough margin for error - you might be wrong. Well let me clarify that. If you KNOW it's worth $120 - say, the present value of the assets is undoubtedly worth $120, then go for it. Because that's certain. But a company like Netflix, a growth play with tons of uncertainty, you have to be sure you are getting a good deal before you jump in. You need more margin for error, because there is greater probability that your analysis is wrong. If Tilson was short $170 with a brilliant analysis, and now he's long $100 for the haul, my question is, what does he think the stock is worth? $135? I mean there is just not enough margin for error there. 

So anyway, maybe he's got a good play now, but his whole reasoning and trade history is dubious.

Now for my analysis:
If I could toot my horn for a minute, I did get a 25% profit in January, buying at $76 and selling at $94 a week later. Tax loss baby! Sorry but I just feel good about that trade. I won't brag about trades too much more. I lose on a lot of trades, too.

I have no idea what Netflix is worth long-term, but here is Porter's five forces analysis that is more bearish than bullish.


Supplier power: High. Movie studios don't like Netflix. They charge a lot for movies. That's why the 'Flix is trying to shift to TV shows. The TV shows studios have lower bargaining power because there are many similar compelling substitutes to each show. Internet companies are getting higher power.

Buyer power: High. Low switching costs. iTunes. Amazon. LoveFilm. Hulu.

Threat of substitutes: High. Youtube. Illegal file sharing sites. Watch TV online sites. Cable. Etc.

Threat of new entrants: High. It's easy to get in this business.

Rivalry: High. Price wars. High marketing costs.

Netflix's lone differentiator is  network effects - so many people subscribe to it, that TV shows will want to offer lower prices to reach all of those people. Is that enough to overcome the other forces against the company?


Netflix's long-term profit margin will be low in my opinion. Like I mentioned before, it was trading pretty cheap compared to its revenues, especially at around $70. If you want to buy it, that's your case right there. But I am not going to buy any shares at $100 because it's just too risky in my opinion. But note that I am very risk averse, because it's better to pass up a good opportunity than to invest in a bad one.