Netflix: Exposing Wall Street's Incomplete Bull Case

NEW YORK (TheStreet) -- Watch my appearance on CNBC with Lazard analyst Barton Crockett. Then allow me to provide context on both the nature of the exchange and Netflix (NFLX), company and stock.

First, between CNBC and CNN, I've been on television several dozen times over the last year or so. Thursday was the first day I really laid into somebody.

I'm not proud of it because I'm not a bully. Nor do I feel vindicated because, quite frankly, it makes no difference to me if I end up right or wrong on the Netflix issue. I care about the story. And I do my best to get it right, which includes telling as much of it as I can.

That's not the case with Wall Street analysts. It's part of their gig to "build the bull" or "bear" case for a stock. CNBC produces several segments throughout its day where they set the scene exactly this way. In fact, they often pit a bullish and bearish analyst against one another in what they call a "Street Fight."

This bull vs. bear dichotomy is not good for investors, at least not insofar as Wall Street analysts are involved. It's one thing for you and I to get together and treat companies and stocks like sports teams. It's entirely another when that's the way analysts on Wall Street -- who have the explicit job description of analyzing companies and making calls on their stocks -- conduct themselves.

And even though Barton Crockett of Lazard isn't the most animated guy in the world, he's a perfect example of an analyst doing a disservice to the public -- and potentially his clients -- by focusing everything he does, at least publicly, on building his bull case. It's akin to an academic researcher collecting only the data he or she knows will tilt the results the way he or she wants them to go.

I've seen Crockett on CNBC before. And I have seen countless others get a pass on CNBC and elsewhere for doing what he did on Thursday. I'm almost ashamed to say that I probably was going to allow the same thing happen again -- I'm not one for conflict -- but something Crockett said (and what he didn't say) set me off.

Simon Hobbs gave Crockett the first chance to speak. Crockett used the opportunity to tell viewers that "Netflix is becoming a TV network company," which provides for a much higher margin business. And because they have signed a couple exclusive deals and consumers like Netflix, margins, along with earnings per share, will continue to increase and the stock will continue to rise.

In response, I noted that it doesn't take a rocket scientist (or Wall Street analyst) to have predicted NFLX would hit $300 (it actually made an intraday high of $298.92 on Thursday). I even did it.

I proceeded to make what I think are the most important points at this juncture in the Netflix (and NFLX) story:
  • There's a disconnect between company and stock.
  • The notion that Netflix is just like Time Warner's ( TWX) HBO is demonstrably false.
  • Off-balance sheet obligations, now at $6.5 billion, have outpaced revenue by a margin of more than 5-to-1 over the last 2.5-to-3 years. Off-balance sheet debt is up 550% over 2.5 years, while revenue is up 106% over the last three.
  • Reed Hastings refuses to discuss churn -- or even look at it -- so he doesn't think anybody else should and nobody says anything about it.

    CNBC's Kelly Evans made a good point in response: Who cares if they're not exactly like HBO? Valid. We might be splitting hairs, although I would argue that exclusivity windows, which HBO has for life specifically because it actually produces its own content, matter. But that aside, if it works, why does it matter how Netflix gets there? Fair enough.

    But I had to ask -- is it even working in the first place? How do we know Netflix originals are hits when the company refuses to provide viewer data?

    Crockett responded by calling my analysis "thin" and claiming I wasn't making "a coherent argument." Honestly, that was shocking, given the data points I offered in response to his vague discussion of improving margins because "Netflix is becoming a TV network company" and consumers like the service. Based on my conception of what a Wall Street analyst should be, I sounded more like one than he did. I mean I had numbers, which, given my qualitative bent, isn't something I usually choose to bring to the table.

    From there, the gloves came off. Simply put, I wasn't about to let another condescending Wall Street analyst slide and continue to "build his case" (something these guys should absolutely not be doing) if he was going to chronically leave key points out of his MBA-like analysis.

    Given the time constraints on CNBC, I had no choice but to interrupt the guy. If we had a half hour or I had my own show, I would not have. But, having seen Crockett and other NFLX bulls on CNBC before, I knew he wasn't going to bring up items such as:

  • Netflix's need to raise to cash twice over the last two years

  • Will Netflix need to raise cash again?

  • The off-balance sheet obligations again

  • The viewership question

    And he sure as hell wasn't going to provide viewers with a clear definition of margins with respect to Netflix. Because if he discussed what contribution profit and margin is (I do in the video), he seriously hurts his bull case.

    And that's exactly where the problem lies.

    While I don't think Barton Crockett or any other Wall Street analyst for that matter purposely misleads people, there's a reasonable chance that that's the end result. Because when your primary concern is building your case -- bullish or bearish -- you would be an idiot to bring up the various bullet points I raise, particularly if you do not have a suitable counterargument.

    Now, in fairness, Crockett gives Netflix a more thorough treatment in the notes that go out to his clients (I assume). Those notes read more like research papers with an outline of alternative arguments and what could derail the bull case. However, Crockett knows as well as I that those sections never make it to print or to air.

    The sad part about it is that there are valid arguments Crockett and others can make in opposition to my points about off-balance sheet obligations, churn, viewership, the cash raises and, as Kelly Evans did, Netflix vs. HBO. But if you don't willingly bring these things up, that part of the discourse rarely, if ever, takes place. And that's a disservice. To viewers. To investors. To thinking humans.

    I expected a negative response to my handling of the discussion. Because I even cringe at such fiery displays of, let's face it, rudeness. But I felt it was the appropriate time and place, particularly when you consider where Crockett did (and didn't) take the conversation. And, based on the response I have received from all corners (readers, viewers, a Wall Street analyst and many fellow print and television media members), more people than I thought appreciate my approach. In fact, the most common reaction I'm receiving via email and on Twitter goes something like this:

    Thanks for doing that. We're tired of Wall Street analysts. We don't trust 'em as far as we can throw them.

    I'm willing to, someday, be wrong about Netflix the company. As I said at the outset of this article, it's not about being right or wrong. Being wrong doesn't scare me. I'm more secure in my work than that.

    I will continue to separate the company from the stock. And, even though you might accuse me of building a straw man, I will outline the bull case for the company to concurrently expose it and give it its due, but also to set up my contention that there's more to the company's story than an epic run to $300 by the stock.

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

    Rocco Pendola is a columnist and TheStreet's Director of Social Media. Pendola makes frequent appearances on national television networks such as CNN and CNBC as well as TheStreet TV. Whenever possible, Pendola uses hockey, Springsteen or Southern California references in his work. He lives in Santa Monica.

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