Netflix Cries Uncle… Sort Of!

| October 10, 2011

Netflix (NFLX) shares have been tumbling since hitting an all-time high of $304.79 on July 13, 2011.  On Friday, the former high flyer closed at $123.24.

That’s a 60% plunge in less than three months!

Prior to July, the world’s leading internet video subscription service had been one of the market’s best performers off the 2008 financial crisis lows.  The stock hit a low of $17.90 in late October 2008 as the financial crisis unfolded.

But then, it was off to the races…

The shares began an uptrend that would last for the next two years and nine months.

Investors piled into the stock as subscription numbers grew… they doubled in just the last 18 months.  And strong revenue and earnings growth didn’t hurt investors’ appetite for the shares either.

By the time the stock set the all-time high in July, the shares had gained an amazing 1,600%.  Investors who bought in near the October 2008 lows had seen their investment increase 15x or more in value.

So, what happened in July to derail the epic run?

That’s when the company announced they were going to raise prices and split their business into two separate entities.

The monthly fee for unlimited streaming plus unlimited DVD rental was set to increase from $9.99 to $15.98 a month… a 60% jump.  And the DVD rental business was to be split off into a separate entity complete with its own website.

The strangest part about this whole plan was the inconvenience to customers.

In order to keep getting DVD rentals, customers would have to set up a separate subscription with the new DVD company, Qwikster.  Those wanting both streaming and rentals therefore would have to maintain two separate subscriptions going forward.

Customers were furious!

To say they didn’t relish paying 60% more for services they were already receiving is an understatement.  Even worse, they were insulted by the company’s seeming indifference to the increased hassle of maintaining two separate subscriptions.

As you might expect, customers began cancelling subscriptions left and right.  In fact, the company recently said they expect to have lost one million customers in the second quarter alone.

To be sure, Netflix was prepared to lose some customers as a result of the changes.  But they weren’t expecting the prolonged backlash customers unleashed.

CFO David Wells described the situation best when he said…

“What we saw was indeed a spike [in cancellations], and it certainly went down, but in prior periods it went down to zero relatively quickly after that announcement period.  What we saw [this time]… was a spike and then a steady response throughout the quarter…”

No question about, customers were livid with the company.

Now it seems Netflix is finally listening to their angry customers… well, sort of.

This morning management announced the company won’t break up after all.  They’re going to keep the DVD rental and online streaming businesses together and under one website.  A company spokesman explained the decision this way…

“We underestimated the appeal of the single website and a single service… We greatly underestimated it.”

Investors greeted the news with raucous enthusiasm.  Netflix shares soared in early trade Monday, opening up nearly 9%.  They’ve leveled off a bit as I write, but the shares are holding steady above $125.

So, is Netflix off to the races once again?

I don’t think so.

I believe we’re seeing an overdue relief rally following the stock’s recent cliff dive.  The seemingly positive announcement gives shorts an excuse to cover.  And we’ll probably see some longs get suckered back in on hopes for another huge upward climb.

But there’s just one tiny problem with the whole bullish scenario…

The price hikes are here to stay.

Yes, the company has decided not to add insult by forcing customers to hold two subscriptions.  But they’re not about to remove the injury by eliminating the hugely unpopular price increases.

While the slight change might stem the cancellation flow, I see a large number of cancellations continuing for the time being.  With the economy still mired in slow to no growth, many people just can’t accept paying more for movies and TV shows right now.

What happens next?

Look for the current rally to run out of steam sooner than not.  When that happens, we’ll likely see the shares head down for a retest of the recent lows around $107.  If the lows hold, that would be a sign the stock has hit bottom.

But if Netflix falls through support at $107… look out!

The shares just might take another header off the cliff.  Given this substantial downside risk, I’m not a buyer of Netflix at current levels.

But if you just have to own it, be sure to put a stop just under the recent lows.  That way you’ll limit your losses if the shares actually do make another leg down.

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Category: Stocks

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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