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Netflix, Inc. (NFLX) Message Board

  • prudent.investor prudent.investor Feb 22, 2013 1:01 AM Flag

    What is Netflix hiding? - NFLX accounting fraud!

    Fund manager, ask yourself, can you trust this company's financial report or management at all? What else is Netflix hiding? Common sense: Do not own a company with accounting fraud!
    --------
    Original article by Shmulik Karpf - February 8, 2013 on Motley Fool Blog Network

    Partial repost of key points of the article:

    Creative accounting employed by Netflix

    During 4Q 2012, the company added $18 million worth of DVD content to its library.

    As every investor knows- the core business of Netflix is to buy DVDs in bulk and then rent them to its end-users. The proper way to treat this massive purchase is to record it as an asset on the balance sheet, and at the same time record the cash expense under 'Cash Flow from Operating Activities' (1st category) because this purchase naturally falls in the category of normal ongoing business operations of the company.

    Netflix, though, doesn't think that way.

    While the company recorded its library as an asset on the its balance sheet, it refrained from recording the expenses accrued by it as an operating cash expenditure (1st category) and rather decided to record it as an investing action to be included in the Cash Flow from investing activities (2nd category). This accounting decision does not correspond with the proper discretion that management is obligated to exercise: investing activities refer to expenditures on such things as plant and equipment, and NOT the purchase of standard inventory that is later sold to consumers.

    The incentive behind Netflix's move

    Cash Flow from Operating Activities is the most closely watched part of the Statement of Cash Flow, whereas the Investing section ("under the line") is usually ignored by most investors and analysts alike. By extracting normal operating cash outflows from the operating section, the Net Cash position misleadingly appears much more impressive than it really is.

    Netflix stands alone

    It's more than interesting to note that Coinstar (NASDAQ: CSTR), one of Netflix's rivals, perfectly understands that expenses for the purchase of a DVD library should be recorded in the operating section. In its most recent quarterly report, Coinstar reported the expenses of its DVD library under 'Cash flow from operating activities,' just as they should be recorded. Perhaps this explains why the darling of the video-rental world trades at an insane P/E of 570x and P/B of 2.6x, while Coinstar, its modest rival, trades at a P/E of 10 and P/B of 0.7. At these prices, Coinstar is well inside the value zone. The difference is even more striking when you consider the fact that Netflix's profit margin is a paltry 0.5%, while Coinstar shines with a profit margin of 8%.

    Another much smaller competitor in the video-rental industry is Hulu. A combined creation of NBC Universal, News Corp (NASDAQ: NWS), and Providence Equity Partners, Hulu offers video rentals and streaming TV. In fact, Hulu is so dominant in its field that it accounted for 43% of total streams in 2012. The thing about Hulu is that it's a private venture, and therefore is not obligated to publicly disclose its annual reports. Hence, we have no way of knowing for sure how it classifies its video library content.

    So, what's an investor to do?

    Avoid holding the shares of a company that is suspected of using dubious accounting tricks. Sooner rather than later, accounting games tend to catch up with the company that employs them. Unfortunately, it is usually the unsuspecting shareholders that get hit first.

    Sentiment: Strong Sell

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