January 5, 2013

Netflix & SEC: Not a Fascinating Social Media Story At All

By EconMatters

Never a dull moment with Netflix!  Last month, the company just announced an exclusive deal to stream Disney movies just months after they are in theaters.  The stock was up 5.5% on the news.  But a couple of days later, SEC ‘friended’ Netflix by alleging Netflix and its CEO Reed Hastings violated the Reg FD (Regulation Fair Disclosure) over a Facebook post by Hastings and is seeking legal action. 

As we previously discussed, Hastings posted on his Facebook page on July 3, 2012:
"Netflix monthly viewing exceeded 1 billion hours for the first time ever in June. When House of Cards and Arrested Development debut, we'll blow these records away."
Netflix was not scheduled to report its full earnings for Q2 until after the market close on July 24.  The company stocks jumped 13.4% in two days after that Facebook update.  The SEC now says that is material investor information that must be disclosed in a regulatory filing or press release (i.e. a Regulation D or Reg D violation).  Netflix, on the other hand, says the information isn't material as the company had disclosed similar info. elsewhere . 

Selective Disclosure? 

Due to the popularity of Facebook and social media, the discussion so far has primarily centered around how SEC should “get with the program” to consider social media as part of public disclosure, while company CEO Hastings called it a "fascinating social media story” via no other than another Facebook update.    

This incident has prompted a firestorm of debate regarding the legality of releasing corporate information via social media, and the SEC has been dogged as “the dinosaur” in this brave new info age. 

However, most people are missing the boat as the more relevant issue is the “selective disclosure” by the Netflix CEO, at least in our view.   
  
Nice Head Fake?

You see, Hastings Facebook post only selectively mentioned one “good” news that would inevitably pump the stock price, and omitted negative news such as the overall operating profit margin of 1.8% was dragged down by more losses of $89 million from international expansion. 

Some analysts at the time believed Reed Hastings' Facebook announcement regarding over one billion streaming hours of video in June gave the market “a nice head fake” sending  Netflix shares up from the mid-60s to over $84 per share. 

As Morningstar put it:
“We don't necessarily view these total streaming consumption stats as bullish (in the long run), as it does not necessarily lead to greater subscriber growth or higher pricing.”
However, to regular-Joe-and-Jane retail investors, Hastings Facebook announcement definitely gave an overall bullish indication of 2Q earnings which would not be officially released 2 or 3 weeks later.  

Some may say that Hastings may not have all the figures since the official earning release was not until almost 3 weeks later.  Then, it is even more irresponsible for a CEO to announce something without all the facts and figures, at least in our view.   
   
In other words, Hastings behavior can’t escape at least a whiff of the possible classic “pump-n-dump.”    
    
When Executive Lacks Common Sense

While the "Facebook Incident" by Hastings/Netflix has been touted as “pushing the envelope” by some mainstream media, we think it actually also demonstrated an incredible lack of “executive common sense.”

Ever since the collapse of Enron and Lehman Brothers, corporate executive behavior and communication has been under the microscope with increasing regulatory scrutiny.  There’s a good reason why almost all Fortune 500 C-Suite executives are very cautious and tight-lipped when speaking to the public about anything with stock price moving potential.   

The reason for this kind of caution is simple – to be responsible to shareholders and avoid dragging the company into unfavorable limelight affecting the shareholder value.  After all, why attract the time-and- energy-consuming regulatory attention when executives should really spend time concentrating on running the company?      
   
Netflix long-term growth story may or may not be valid given the potential competition from Google, Apple, to name a few, but for now, we say think twice before throwing money at a company run by an executive who appears quite low on common sense IQ, to say the least.  


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