Tuesday, November 22, 2011

Piss Poor Capital Allocation At Netflix.

Netflix has had a heck of a ride the past few years. Here is a link to Whitney Tilson talking about management's move to issue stock.


“When you’re betting on a medium- to long-term turnaround, you first have to make sure that the company doesn’t hit a cash shortfall in the short term. …[T]his capital raise is a good insurance policy.

That said, it is irritating to see a company we own issuing stock at 1/3 the price at which it was buying it only months ago – yet another example of the capital misallocation decisions that are all too common in Corporate America….Netflix should have done a big secondary and issued a lot of stock in the $200-$300 range.”

As we have seen in other areas, price, value, and the potential for returns generated elsewhere are about the only things that should matter when a company issues or buys back stock. When a company makes a boneheaded move, it destroys shareholder wealth. But, as Tilson points out, it will keep the company solvent. Though, Netflix does already have a nice bit of cash on the balance sheet; they must be getting ready to spend a ton on their expansion, or things may be getting REALLY bad for them operationally. Regardless, it's a shame for the company's shareholders that the management of Netflix doesn't appear to have seen how the situation was going to play out, as this dilution has effectively canceled out many quarters, even years worth of share repurchases... Keep in mind, that these previous share repurchases were all done pretty aggressively AND at a significantly higher prices. Granted, if they can re-allocate the raised funds in a manner that is better than the company would do without, it could be accretive to the company, but, still... they were repurchasing shares as recently as LAST QUARTER!

Now, contrast this with a company like Nevada Gold, which, when it issues or buys back stock, does so in a sensible manner: buying low, and selling on terms that make a fair to great amount of sense for the company. Whether it's the acquisition of the Red Dragon card room or AG Trucano, Sturges and Kohn (unlike Reed Hastings) have a history of good capital allocation, and have yet to become the subject of some pretty good satire.

When looking at the capital allocation of various corporations, what kind of company do you want to invest in?

EDIT: Adam, at The Investments Blog, does a good write up on the situation at Netflix as well. He even went to the trouble of adding in a nice chart that shows you where the previous buybacks were made.

Disclosure/Disclaimer: I have no position in Netflix, but do own shares of UWN. My positions can change at any time, for any reason. This is not advice of any kind. Always do a ton of your own research in regard to anything that I say, do, write, or so much as even think about.

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