The whole point of a CEO is to improve the stock price of a company, essentially. In a public company, the CEO is hired by a board of directors, which is a body elected by shareholders. And, as such, when the board makes a decision on who to place in charge, it’s usually pretty clear that they’re expecting to see returns in their portfolio. Sure, a CEO has a lot of responsibilities, but in the end, the granddaddy of them all is ensuring that the people who hired them are getting a return. So why, on earth, would a CEO ever suggest that their stock's price was too high?
Reed Hastings Doesn’t Like Money?
That’s what makes Reed Hastings comments in Netflix’s (NFLX) most-recent earnings letter somewhat bewildering. Hastings inserted the following comment under the heading “Stock Volatility”:
In calendar year 2003 we were the highest performing stock on Nasdaq. We had solid resultscompounded by momentum-investor-fueled euphoria. Some of the euphoria today feels like 2003.
Despite the huge swings in our stock price since our 2002 IPO ($8 to $3 to $39 to $8 to $300 to $55 to $330), we’ve continued to grow our membership every year fairly steadily. We do our best to ignore the volatility in our stock. The progress we’ve made over the last 10 years is stunning. We want to make the next 10 years even more remarkable.
Wait, what? Is Reed Hastings COMPLAINING about the astronomical value of Netflix stock? That seems like an awfully odd choice to make, given that A) his job is tied to stock performance and B) as a man with a 4.5 percent stake in Netflix the nearly 400 percent gain over the last year has increased the value of his stock from $181 million to just over $855 million. Thing is, he’s not alone. Here’s something Tesla (TSLA) CEO Elon Musk told CNBC in late August regarding his company’s meteoric rise:
I’m never a fan of trying to sort of pump the stock up, convince people the stock should be higher, or even convince people that the stock should be what it is right now. … I mean, the market’s being very generous, and they’re obviously giving us a lot of credit for future execution. … I really feel like the valuation we have right now is more than is more than we have any right to deserve, honestly.
And Tesla’s up another 16 percent since Musk made those statements.
So what gives? Why wouldn’t Hastings be happy, nay, overjoyed that investors seem ready to fall over themselves to get to shares of Netflix? Does he not WANT an additional $700 million? The same goes for Musk, who’s 32 percent stake in Tesla has more than quintupled in value in 2013. If people are buying, why rock the boat? The short answer would be volatility and a desire to give the company smooth sailing.
Why is $300 a Share So Familiar?
One need not go too far back to see why Reed might have trepidations about investor enthusiasm. The last time Netflix stock sniffed $300 a share was in July of 2011. At the time, Netflix was just getting into the online streaming game and remained primarily a mail-rental DVD company. Hastings, believing that his company’s future lay elsewhere, announced that the company would be splitting its DVD service off into a separate service. The change meant that maintaining both a streaming account and a DVD account would cost 60 percent more than it had. What’s more, the separate DVD service meant maintaining separate queues on separate sites. It was immensely unpopular, resulting in a massive loss of membership, extensive bad publicity, a pretty brutal skewering on social media (even by social media standards) and a huge sell-off in the company’s stock. Netflix plunged to under $64 a share from $295 by Thanksgiving, a nearly 80 percent loss in just under five months.
The thing that’s crucial to understand here is that Reed Hastings was right. Incredibly right. Hastings and Netflix were downright prophetic in their ability to foresee the rise of streaming and how original content could boost Netflix earning potential. While many laughed when Hastings stated that he viewed HBO (TWC) as his primary competition, he actually had a much better grasp on the situation than most investors (and his customers, who are now streaming back at a rapid rate, with at least some of them now realizing that Hastings actually had a better idea what they wanted than they did two years ago).
Earnings Were Good, but Not THAT Good
Now, with Netflix over $300 a share again because of the very decisions that caused it to fall so far from that level two years ago, Hastings is clearly not planning on going through all this again. The massive plunge in stock price in 2011 very nearly cost him his job, which, at this point, it’s clear he’s quite good at. And these rapid fluctuations in value aren’t good news for the sort of institutional shareholders Netflix undoubtedly wants to attract. Hastings may enjoy having his stock skyrocket, but he clearly isn’t forgetting what it’s like when the bottom falls out.
And Monday’s earnings report most likely backs him up. Sure, it was good. Sure, $0.52 a share beat consensus estimates by $0.04 a share. Sure, 31.1 million US subscribers means Netflix is crushing HBO. But that doesn’t mean that the current price, to some, is completely insane by almost any form of fundamental analysis. Tuesday’s closing price of $322.52 a share, which, incidentally, came after a sell-off that saw shares drop 9.15 percent, is still pretty high as compared to those earnings. In fact, it’s good for a price that’s more than 400 times its 2012 earnings. Reed Hastings undoubtedly had that in mind when he made his comments on volatility. Even a series of similar earnings beats will most likely still leave Netflix earnings lagging well behind its price. And, as the enthusiasm of said momentum investors wanes, his company could be looking at another sell-off that will only contribute to the perceived lack of stability the stock already suffers from.
Musk’s concerns about Tesla’s stock price are rooted in similar realities. While everyone’s pretty excited about the potential for his new sedan to reach a much larger audience, he’s still the CEO of an automobile maker with a valuation of over $20 billion that’s on track to produce 20,000 cars this year. So, basically, $1 million a car. Like Hastings, Musk is probably guessing that reality is going to catch up to his stock sooner or later, and, when it does, it’s going to send the momentum investors running for the hills.
Stability Beats Volatility for Some
Big gains are all well and good, but Hastings and Musk might be telling the market that they would trade them for some predictable, stable returns that won’t disappear just as rapidly as they appear. In the end, big swings in value aren’t always a positive for a company. Stable investors who will buy and hold a stock tend to help a company’s long-term health much more than traders looking to make a quick buck, and that’s why CEOs like Hastings and Musk are willing to make statements that could drive off some of their shareholders. Whether they're right or not, neither Musk nor Hastings appear to want to court momentum investors.
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