Netflix had a chance to dominate online video streaming for the foreseeable future.  With a high priced stock they could have issued equity to purchase the rights to various properties that would have made them the HBO of online video.  Now the company is forced to issue dilutive convertible debt in the face of a falling stock price and weakening earnings.

Source:  Bespoke

What was Netflix doing when its stock price was on the way up?  Buying back stock.  According to various reports Netflix spent nearly $200 million to buyback shares at an average price around $222 a share.  We can’t be sure what management was thinking, but ponder for a minute if instead of buying back shares the company had been issuing shares along the way instead of buying back shares.  Conducting an offering to “strengthen its balance sheet” would be off the table at this point and chatter about its financial future would be decidedly different.

Hindsight is of course 20/20, but Netflix is not alone in making the mistake of thinking that share buybacks are in any real fashion value enhancing activities. Indeed stock buybacks are a deeper reflection of short-term thinking in Corporate America.  In a macro sense this kind of thinking leads to a sub-optimal amount of investment in a country desperately in need of more jobs.  Nelson D. Schwartz at NYTimes today highlights criticism of executives for focusing on share buybacks in contrast with the need for long term investment.

“It’s a symptom of a deeper problem, which is a lack of investment in the long term,” said William W. George, a Harvard Business School professor and former chief executive of Medtronic, a medical technology company. “If we’re not investing in research, innovation and entrepreneurship, we’re going to be a slow-growth country for a decade.”

Nor does it seem like these buybacks lead to better future stock performance.  Schwartz writes:

Over the last decade, in fact, companies that spent the most on repurchases had a total shareholder return of 37 percent versus 127 percent for companies that spent the least, according to research by Gregory V. Milano, chief executive of Fortuna Advisors, which consults with companies on how to raise their share price over the long term.

If share buybacks don’t lead to higher stock prices and are ultimately starving company’s long term investments then what are they good for?  In contrast dividends, provided they are not borrowing to fund them, don’t have the issue of perverse incentives for management.  The use and abuse of share buybacks is ultimately a failure in corporate governance.  Then again, maybe we shouldn’t expect better behavior given the generally poor state of governance in the US these days.

Items worth a look:

Netflix to raise $400 in fresh cash.  (Deal Journal)

Netflix buys high and sells low.  (Bespoke)

Has Netflix overexended itself?  (GigaOM)

On the sly, Netflix brings down estimates for 2012. (Herb Greenberg, Tech Trader Daily, SAI)

[earlier] The real failure at Netflix ($NFLX).  (Abnormal Returns)

Analysts react to the Netflix news.  (MarketBeat)

Share buybacks are on the rise, to what end?  (NYTimes)

[earlier] Dividends versus share buybacks. (Abnormal Returns)

Super committee failure puts US at risk.  (Politico)

*No position in Netflix. Long time subscriber.

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