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Netflix Lies to Canada and Insults America

By Jim Fink on September 27, 2010

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Netflix (NasdaqGS: NFLX), the DVD-by-mail rental company, is up an astounding 194% so far this year, the second-best performing U.S.-listed stock with a market cap of at least $2 billion. The company has done so well primarily because of its “Watch Instantly” video streaming service that allows DVD-by-mail rental subscribers to watch movies online for free through the Netflix website. The recent bankruptcy of chief rival Blockbuster didn’t hurt either.

Sure, I myself am a Netflix subscriber with the “one DVD out at-a-time unlimited plan” for $8.99 a month. But that doesn’t mean that I like the stock. As I stated in a recent advisor roundtable this past July, I think Netflix is overvalued and faces increasing competition that will hurt profit margins. So far, my short call has been obscenely wrong but I’m keeping the faith, confident that the stock’s parabolic blow-off move so far in 2010 will end in tears within a year’s time. 

Canadian Lies

The company’s missteps in Canada increase the likelihood that the stock is primed for a fall. Back in July, Netflix announced that it was expanding into Canada, its first international foray outside of the U.S. Unlike in the U.S., the Canadian offering would be limited to the “Watch Instantly” video streaming service for $7.99 per month; no DVD-by-mail rental service will be offered. Last October during the company’s Q3 2009 conference call, Netflix CEO Reed Hastings said that the company would not be offering rentals by mail outside of the U.S. because “postal systems in many nations make that tricky.” This doesn’t make sense, at least in Canada’s case, because a Canadian company called zip.ca already provides a DVD-by-mail service very successfully. I think that the real reason Netflix won’t offer it is because it would be costly to create a Canada-based infrastructure that would deliver physical DVDs in a timely manner.

International expansion promises growth, which is usually good for a stock price. But then Netflix had to ruin everything by lying to the Canadian people. On September 22nd Netflix held a news conference in downtown Toronto to announce its launch in Canada. The event appeared to be a big success, with dozens of the Canadian public attending and acting very enthusiastic and excited. There was only one problem: many of the “excited” Canadian bystanders that members of the press interviewed were paid actors. A handout sheet for the actors told them to play character types like “mothers, film buffs, tech geeks, and couch potatoes.” The instructions also said the following:

Extras are to behave as members of the public, out and about enjoying their day-to-day life, who happen upon a street event for Netflix and stop by to check it out. Extras are to look really excited, particularly if asked by media to do any interviews about the prospect of Netflix in Canada.

If real members of the public are too shy to approach Netflix staff, it is the job of the extras to help boost energy and break the ice by asking questions and showing enthusiasm.

The next day, Netflix issued an apology on the company’s blog:

We didn’t intend to mislead the media or the public, and we can understand why some have raised questions. We’re sorry that our misfire has given Canadians any reasons to doubt our authenticity or our sincerity.

My take: this “apology” just makes matters worse!  Why compound a lie with another lie. The use of paid actors was obviously meant to mislead. Why deny it? It just makes Netflix look doubly duplicitous. I bet zip.ca is just laughing all the way to the bank with this Netflix fiasco. Sure, Netflix’s lower price and greater offerings of streamed movies will take some market share away from zip.ca, but the damage will be a lot less than it would have been if Netflix had launched the product honestly.

American Insults

Not content with offending Canadians, CEO Reed Hastings wasted no time insulting Americans. In an interview with The Hollywood Reporter, Hastings was asked if he was worried that U.S. subscribers would be upset that the company was offering Canadians an unlimited movie streaming service for $7.99 per month, one dollar less than what Americans had to pay. Hastings replied:

How much has it been your experience that Americans follow what happens in the world? It’s something we’ll monitor, but Americans are somewhat self-absorbed.

Wow. Netflix basically told all Americans that we’re dumb and unobservant. Great public relations, Reed!  Hastings issued yet another Netflix apology on its blog:

My Big American Foot is in my mouth. I do not believe that one of the most philanthropically-minded nations in the world (America) is self-absorbed or full of self-absorbed people. My apologies to anyone offended by my self-absorbed comment.

Canadian Edge Has a Better Investment Idea: Cineplex Galaxy

Netflix may be flying high now, but the two public relations disasters that occurred last week are symptomatic of a company suffering from arrogance. As Proverbs 16:18 teaches us:

Pride goes before destruction,
And a haughty spirit before a fall.

Roger Conrad, editor of the top-performing investment advisory Canadian Edge, has found a better investment opportunity in video distribution: Cineplex Galaxy Income Fund (Toronto: CGX-UN.TO) (Other OTC: CPXGF.PK). Cineplex Galaxy, which Roger added to the “Conservative Portfolio” in Canadian Edge on June 4th, is Canada’s dominant movie-theater operator with more than 1,000 screens using the latest, greatest display technology. It also sells DVD movies online and is developing a digital movie download service with Best Buy CinemaNow.  Cineplex, which has never cut its dividend, plans on converting to a corporation on January 1, 2011 and has announced that its 6.2% dividend will remain the same after conversion. In other words, Cineplex joins the ranks of the strongest Canadian income trusts that have announced a “cutless conversion.” Roger recommends Cineplex for the following reason:

Cineplex Galaxy is the essence of a strong income-generator: It occupies a dominant position in a business with reasonably easy to predict cash flows. At these levels, around USD20 a unit, even with a management team more focused on preserving long-term sustainability, Cineplex Galaxy still yields more than 6 percent. This is the way to get rich off Hollywood: slow and steady.

What’s amazing to me is that despite the parabolic up move by Netflix this year, Cineplex Galaxy has performed almost as well since its IPO in 2003:

Source: Bloomberg

In fact, the chart shows that Cineplex Galaxy has outperformed Netflix for almost its entire existence, only falling slightly behind starting in March of this year. When one takes into account that Cineplex Galaxy has a much cheaper valuation than Netflix and pays a 6.2% dividend while Netflix pays zero, Cineplex Galaxy looks like the better buy going forward:

 

Company

P/E Ratio

Price-to-Book

Debt-to-Capital

Dividend Yield

Market Cap

Cineplex Galaxy

20.9

1.9

37.4%

6.2%

$1.1 Billion

Netflix

66.5

48.1

56.8%

0.0%

$8.5 Billion

Source: Bloomberg


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