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Netflix CEO takes on short seller Add to ...

When a chief executive talks up his or her own stock, is it bullish or bearish?

Investors have been left debating this question on Monday after Reed Hastings, chief executive of Netflix Inc., addressed a particular short seller’s concerns about the high-flying, online movie rental company.

This is unusual, to say the least, and what makes the response even stranger is that both Mr. Hastings and the short seller – Whitney Tilson, founder and manager of T2 Partners LLC – share the same charitable interest. This shared interest dictated the tone of the response.

“Whitney is such a big-hearted donor to causes that I care about that I am writing this open letter for him to try to get him to cover his short now,” Mr. Hastings said in his note, published on Seeking Alpha. “My desire is to increase his odds of making money next year so he can donate even more to the charter public schools that we both think are important to our country’s future." In other words, he’s defending his stock, but only in the interests of short sellers – he says.

But let’s start with Mr. Tilson’s take-down, also published on Seeking Alpha. He fully acknowledges that Netflix offers a useful service that is attractively priced, and the company has been growing fast.

However, he’s worried that the company’s growth trajectory may be over-estimated, given a market that is saturated and has well-heeled competitors, and he’s concerned that bandwidth issues might ultimately affect the cost of the service.

The stock’s valuation doesn’t reflect these concerns: Netflix’s share price has zoomed an incredible 224 per cent this year, making its climb look unsustainable. From a valuation perspective, the shares trade at about 68-times trailing earnings and nearly 59-times estimated earnings, putting the stock in nosebleed territory.

“By any measure, Netflix's valuation is extremely rich,” Mr. Tilson said. “In short, the stock is priced for perfection, and any misstep would likely trigger a huge selloff.”

Mr. Hastings attempts to knock down these concerns. Market saturation is a long way off, he said, and competitors are faced with a key barrier to entry: Netflix’s happy subscriber base.

“Our large subscriber base is very happy with Netflix, and tells their friends about Netflix,” he said.

He may be right. But investors are far more fickle, and even Mr. Hastings agrees that Netflix’s valuation is “substantial.”

“It is possible that one could make money shorting Netflix today,” he concluded. “But shorting a market-leading firm as it is driving a huge new market is a very gutsy call.”

Who knows how this will turn out. However, Netflix’s share price was down a little in afternoon trading on Monday – and the shares have slumped 13.5 per cent since the start of December, while the S&P 500 has risen 5.8 per cent.

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  • Updated May 27 4:00 PM EDT. Delayed by at least 15 minutes.

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