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Cramer: Short Selling Doomed Netflix

Stocks in this article: NFLX

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NEW YORK ( RealMoney) -- How can Netflix (NFLX) fall and fall and fall some more over the same sagging data? How can the company be worth a small fraction of what it was just a few months ago?

The answer lies in short sellers and the flawed process of betting against stocks.

Cramer: You want to know why Netflix had such a spectacular rise and fall? Blame management, but also blame the short sellers.

When you buy a stock, it's pretty simple. You place an order, a seller is found, you get your report. Usually there are so many sellers at once that unless the stock is incredibly thinly traded, say a couple of thousand shares a day, an order of any magnitude is pretty much handled in line.

But a short seller has a different set of rules. If you want to sell something you have to own or borrow it first so the buyer gets delivery of the stock. When you own it, of course, you sell it and the buyer gets the shares. But if you sell it without owning it, what does the buyer get? Does he get a notice saying "sorry stock unavailable?"

No, the buyer won't tolerate that. So the short seller has to borrow the shares, typically from what is known as the broker's electronic vault. Only after the shares have been located can the short seller go to work betting against the stock.

Now there were always deep suspicions about how long Netflix could grow. How many people want to get DVDs in the mail? How large is that audience? Aren't there plenty of alternatives, whether it be Blockbuster, or Coinstar (CSTR) or video on demand from your cable operator?

But the company, during the days when the distributors of films and television programs were hurting, managed to lock up a tremendous breadth of product that made Netflix a joy to be a part of.

When people thought that the DVD market was getting saturated, Netflix introduced a streaming service that was wildly popular and answered the critics' worries about the next leg of growth after DVDs.

As this company grew subscribers, the number of people who thought this Netflix business would hit a wall increased almost by the day. The critics felt that either subscriber growth would peak or the cost of content would skyrocket as studios recognized that while they needed the money Netflix offered, they could play hard-to-get now that times had improved. So, they sought to short it with reckless abandon.

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