Microsoft Should Not Buy Netflix

TheStreet.com

NEW YORK ( TheStreet) -- You never want to receive HUH? as a response from Jim Cramer. But even if he snarls at me in the halls of 14 Wall Street, I will live life on the edge. As explosive as ever. And, as the great Tom Petty said, I Won't Back Down.

That's exactly the attitude I took in 2011 as Netflix powered past $300. I remained bearish, knowing that we had a fundamentally broken company with a jive-talking CEO floating a classic momentum stock.

Netflix's late-2011 implosion delivered vindication.

Today I am on the right side of the trade, however my feelings haven't changed much about Netflix, the company.

Despite a better-focused content acquisition strategy, Netflix might be in worse shape now than it was in 2011. The notion of Microsoft bailing Netflix out sends me running for pint glass.


While it would not surprise me to see Microsoft CEO Steve Ballmer make a move on Netflix -- it fits with his ongoing ineptitude -- it could end in another write-down or merely something even more embarrassing than Surface Tablet and Windows Phone sales figures.

Monday on Twitter, Cramer responded to my ridicule of a Netflix/Microsoft hookup with the feared "HUH?":

Contrary to what several Tweeters and commenters believe, I am not contractually obligated to agree with Jim Cramer. In fact, I have been instructed to push him so far to the edge that he starts throwing computers again like he did back in his hedge fund days. I set my bar of insubordination high, straight to the founder!


Here's why a Microsoft-Netflix deal, even if it happens, is misguided:

1. Netflix's cash situation is deteriorating once again. Just like it did in 2011. See support for this contention in last week's Reed Hastings Hypnotizes Wall St. Analysts.

2. No matter how Netflix tries to explain it away (likely at the urging of the SEC), the company still has $5.6 billion in off-balance sheet, streaming content obligations, as of the end of the year, compared to $4.8 billion at the end of 2011. Nearly $2.3 billion of that is due in less than one year; roughly $5 billion of it inside the next three years.

3. Pursuant to No. 2, why would Microsoft, or any other company for that matter, want to assume what amounts to billions in debt to pay for largely non-exclusive content? It just doesn't make any sense. Microsoft, in particular, does not need Netflix to enhance Xbox. Why take on somebody else's problems?

4. Netflix is also spending millions on marketing, international expansion and original programming. Free cash flow continues to decrease. This is all public information. Available in the same annual reports and 10-Qs on the SEC Website that Wall Street ignored or chose to downplay in 2011.

5. If this was the story of a perpetual startup with a track record of execution spending money and sacrificing the balance sheet and bottom line to seize massive and realistically attainable long-term opportunity -- like Amazon.com -- I could overlook the quantitative writing on the wall. However, the qualitative story sucks as well . . .

Hastings spins everything positive. He situates the international expansion and original programming pushes as proof Netflix is on the right path when, in fact, it's these very moves that should trigger red flags.


Netflix has no choice but to head overseas and, in particular, take a long-shot bet on original content because there's no way it can survive as a third-party player licensing, by and large, non-exclusive, non-premium content. This is all eerily similar to how things came apart in 2011.

Everything was rolling smoothly, but it crashed when Hastings split streaming from DVD and raised prices. These moves triggered Netflix's crash, but ultimately they benefited Hastings. He was able to point to Qwikster and the price hike as temporary obstacles that would take time to overcome, but, once Netflix got past them, everything would be all right again.

He masterfully took control of the story and shifted focus away from Netflix's broken business model. Today, he operates along similar lines, using international expansion and original programming as evidence that Netflix operates from a position of strength. It does not. From any objective quantitative or qualitative standpoint, this is obvious.

Netflix needs a miracle to achieve the level of success it requires internationally and with originals to survive. But that's what Hastings does. He sells miracles. Ice to Eskimos. He turns busted and unsustainable business models that require cash infusions to stay afloat into opportunities. Wall Street laps it up so it should come as no surprise if, eventually, Steve Ballmer does as well.

And people have the nerve to criticize Jeff Bezos at Amazon. Or, worse yet, suggest that he might be willing to make a Ballmer-like mistake and take Netflix off of its shareholders' hands.

--Written by Rocco Pendola in Santa Monica, Calif.

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