Greenberg: The Last Short Standing in Netflix


With Whitney Tilson of T2 Partners throwing in the towel on his Netflix short and Netflix hitting another new all-time high today, Lenny Brecken of Brecken Capital really may be the last short standing.

Two of his main points:

  • He believes Netflix’s earnings are overstated by the way the company amortizes content costs. According to his analysis, the ratio of content costs to amortization in the fourth quarter was half of what it was in the third quarter of 2009. At the same rate as it had been, he says, earnings would have been negative for the third and four thqarters, while 2010 pretax income would have been reduced by more than 80 percent.

A spokesman told me the ratio is impacted by the number of big deals the company has done “that have us booking it to the balance sheet the next year before they’re amortized. It’s a function of large growth in streaming spend that will correct once spending starts to flatten out. The same thing happened in DVD as we built out the DVD library faster than we amortized it.”

  • He believes company is masking cash flow declines by ballooning accounts payable. His analysis shows that if 2010 operating cash flow were adjusted for the accounts payable rise it would fall below 2005 levels.

On the most recent earnings call, Netflix CFO David Wells addressed the issue: “If you look at the balance sheet and the cash flow statement, you'll notice that we had a significant increase in the investment in our streaming content library, and, so, a couple of these were large payments that just were timing at the end of the quarter that should reverse themselves in the first quarter.”

On air today, Brecken told me he believes these issues will ultimate hit the financial statements in the second or third quarters when Netflix “saturates the 24 to 35 age category, which I think they are doing.” (Watch video of my TV interview with Brecken above.)

He also believes Amazon will become a formidable competitor and that the stock’s true value is sub-$70.

My take: I’ve seen this movie before and I’ve seen both endings. If nothing else, in momentum-driven markets and stocks investors generally roll their eyes over accounting-related and earnings quality issues.

They simply don’t matter if the business model either is or appears to be powering through. The danger, especially for companies with seemingly robust valuations, is the risk they eventually will. With Netflix, clearly Wall Street is betting they won't.

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Follow Herb on Twitter: @herbgreenberg


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