Tuesday, October 25, 2011

Netflix's About Face On Splitting Services

According to its stock price history, it is clear that Netflix has yet to recoup the massive shareholder value damage which occurred when the firm's CEO first announced the splitting of the firm into online and physical dics video delivery. The nearby 3-month price chart for NFLX and the S&P500 Index, through Friday, clearly displays that. It got worse after the close yesterday when Netflix released earnings and reduced projections for the fourth quarter.

Now about a month old, the furor which the move touched off among investors and customers prompted the firm to reverse its decision a few weeks ago. I wrote in this post a little over a month ago,

"Hopefully, Hastings will go all the way and spin the two businesses- Qwikster and Netflix- into two separate public companies. The segmentation, costs and overall business dynamics are so different as to make that entirely sensible.

As for the anger some customers are experiencing? Get over it. Say goodbye to a business model that simply isn't viable at older price levels anymore.

As for the effect on Netflix's equity price, that's not entirely surprising, either. Thus the benefit of splitting the businesses, with either some sort of transfer price from one unit to the other for content, or a priori shared purchase of said content. In time, the two units should have dramatically different values and growth rates."

Looking at a 6-month chart of the same two series, and noting Hasting's reference, in his September 20 email to customers, that the firm had announced its new pricing structures a few months earlier, one can see that the firm's equity price stopped rising at that point. The formal announcement of a split caused a cliff-like drop in the share price.

Contrary to my own hopes, Netflix has totally reversed itself on splitting, but kept the pricing changes. Probably the worst of all worlds.

Now we'll never know how the online component would have fared alone, although, as I originally noted, there would have been some short term challenges to cost allocations of content acquisition deals.

Unlike the initially-disastrous New Coke introduction decades ago, which ultimately resulted in a new flavor becoming permanent, and more shelf facings for Coke products, I think the longer term consequences of Hastings' dithering, then reversing his company-splitting decision will be negative.

To me, Hastings' actions reflect one or both of two negative components of his decisions as the firm's CEO. To reverse himself on such a crucial customer service issue as splitting the company into online and disc suggests that either Hastings and/or his staff didn't possess a high level of confidence in their knowledge of their customers. One would hope they would have conducted some primary research with a sample of their customers, chosen by usage patterns, to get a good sense of their reactions before even announcing the price changes. That's profoundly poor general and marketing management.

For Hastings to compound this with his missteps regarding splitting the firm shows weakness as Netflix's CEO in understanding what is essential for the firm, going forward, in order to continue to deliver total return to shareholders. Because the decision involved not just investors, but customers, as well, that, too, should have been researched. The reversal of the decision again suggests it was not.

Prior to this past summer, Netflix appeared to be a dominant, well-managed video content delivery firm. In the wake of its actions since the summer involving pricing structure changes, and then corporate structure changes, the core competence of its management team is now in question.

That's reason enough for an investor to be open to reassessing the firm's attractiveness as an investment.

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