Should Netflix Shareholders Follow Carl Icahn?


After a tumultuous couple of days for Netflix shareholders, one of the company's biggest, Carl Icahn, tweeted out a message to his 100,000-plus followers.

Sold block of NFLX today. Wish to thank Reed Hastings, Ted Sarandos, NFLX team, and last but not least Kevin Spacey:

— Carl Icahn (@Carl_C_Icahn) October 22, 2013

This news comes a day after CEO Reed Hastings wrote in his letter to shareholders, "Some of the euphoria today feels like 2003."

NFLX Chart
NFLX Chart

NFLX data by YCharts.

Should investors heed the warning of the CEO and take some money off the table like its biggest shareholder?

Riding the momentum
Anyone who tells you Netflix has good fundamentals is either lying to you, lying to themself, or just doesn't know what they're talking about. The stock trades for about 100 times forward earnings estimates and nearly five times its sales. Both metrics are well above industry averages.

Netflix trades on a very unorthodox metric -- subscriber growth. When Netflix crushed its subscriber growth estimates in the third quarter, the stock rocketed up after-hours on Monday. It trades like Tesla and SolarCity , on momentum and market sentiment, which can cause a bumpy ride for those brave enough to hang on.

But with Hasting's warning and Icahn selling half of his stake, is the momentum dying?

Subscriber growth
Netflix added nearly 2.75 million new subscribers last quarter fueled largely by 1.44 million new international subscribers. The company sees huge potential in the international market, expecting to generate 70% to 80% of revenue outside of the United States.

The opportunity is certainly there. HBO has over 114 million subscribers globally, only 30 million are in the U.S.. Netflix's domestic subscriber count is now larger than HBO's, indicating Netflix's potential subscriber count could be higher than 114 million.

Can it keep this up?
Since the "Qwikster" debacle of 2011, Netflix has grown subscribers nearly 75% globally and 50% domestically. It's still $7.99 a month per subscriber, and it's been able to keep its price that low due to its huge subscriber growth.

But that subscriber growth has been fueled by Netflix's huge spending: its content deals see higher and higher price tags every quarter. The company plans on spending twice as much on original content in 2014 compared to this year, and its international expansion efforts do not come cheap.

It may be able to raise prices to fuel growth, but the last time it did that shareholders were none too happy. Now, Netflix has even more subscribers to lose if it miscalculates how much they'd be willing to pay for the service. Its pricing power may not be that great.

Another option
Hastings could take a play out of Elon Musk's book. The CEO of Tesla and SolarCity has approved secondary stock offerings for both firms in 2013.

As Tesla shares boomed earlier this year, Musk made a secondary stock offering raising over $300 million in capital in May. The offering helped pay off Department of Energy loans well ahead of schedule and accelerate production on the company's popular Model S. Tesla shareholders didn't seem to mind, as the stock continued to zoom up in price.

SolarCity recently announced that it would issue 3.4 million shares in a secondary stock offering to fuel growth in 2014. Overall, the company expects to deploy 70% to 90% more solar-energy power next year compared to this year. The secondary stock offering will accelerate deployment, and allow SolarCity to make strategic acquisitions, such as component supplier Zep Solar.

Although Hastings denied plans for a secondary offering on the third-quarter conference call, it still remains a viable option. Considering Hastings, by his own admission, believes the stock is relatively expensive, now is probably the best time for the company to make the offer -- you want to sell high.

What did we just see?
The momentum is still there for Netflix. At least for now, subscriber growth is booming. But the question is, how long can Netflix keep this up? Without raising prices or making a secondary offering, Netflix will be hard-pressed to continue expanding at a rate remotely close to the last two years.

Perhaps the stock's movement earlier this week was pricing in the potential for a secondary offering. With that weight and half the weight of Carl Icahn's potential sale removed, Netflix shares may continue to climb.

At this point, if you're bullish on Netflix, I wouldn't sell. I'm bearish. But, that doesn't mean I'm about to short a momentum stock.

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Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Netflix and Tesla Motors. The Motley Fool owns shares of Netflix, SolarCity, and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published