What does the recent announcement by Netflix, indicating that subscriber growth was lower than expectations for the third quarter of 2014 and the resulting devastation of market value have to say to owners and managers of closely held and family businesses?

First, what happened. Netflix (NFLX) closed on October 15th at $448.80 per share, representing an equity market capitalization of just over $27 billion. Shortly after the market closed, Netflix management announced a number of things:

• EPS of 96 cents per share, or 3 cents ahead of consensus estimates and up 85% from one year earlier. (good)
• Revenue totaled $1.41 billion, up 27% and in line with analysts’ expectations (good)
• Free cash flow turned negative after five quarters to the good (not good)

The markets might have overlooked the cash flow turn, but Netflix also made announcements about subscriber growth. At the beginning of the third quarter, management had forecast that the number of streaming subscribers would grow 3.69 million during the quarter. Now that’s a pretty specific number.

Netflix also announced that only 2.04 million international subscribers versus its earlier estimate of 2.36 million new international subscribers. Finally, they announced they added only 980 thousand domestic streaming subscribers versus their estimate of 1.32 million new subscribers.

If my math is correct, Netflix fell short of expectations by 1.33 million new subscribers

Following the announcement, according to Investor’s Business Daily, investors “changed the channel and dumped Netflix.” The stock plummeted from its close of $448.80 per share to $334 per share in after-hours trading (don’t they get enough during the day?), or 25.6%.

My mind works this way sometimes. Market capitalization dropped 25.6%, or $6.9 billion. So the market devalued Netflix by almost $52 thousand per missed subscriber. Pretty expensive.

And guess what? Netflix gave guidance for the fourth quarter of this year at 4 million new subscribers.

So the market reacted with great disappointment to the fact that Netflix’s subscriber growth might be slowing, or at least might be slower than “expectations.” That’s Netflix. I didn’t own any yesterday and I hope you didn’t either.

How Can We Relate This Netflix Surprise to Private Businesses?

My first observation is that I’m glad that my firm, Mercer Capital, is privately owned and that our investors are a bit more patient than those of Netflix. After reading this, I bet you are glad that your company is private, as well (at least most of my readers are in closely held and family businesses).

The second is that, particularly with pricey stocks where the market is expecting rapid growth, adverse surprises are often met with seemingly disproportionate responses. Some time ago, I wrote about a similar negative surprise with Zynga.

My third thought relates to time and timing. When I see things like happened yesterday to Netflix and to Zynga some time ago, it causes me to reflect. These were bad things that happened to these companies and costly for their owners. But bad things happen to good companies, even possibly (but hopefully not) to yours.

Events like Netflix’s announcement make me think about doing things while we can. What I know is this:

When it is too late to do something, it is simply too late.

This can relate to obtaining financing, hiring the right people, transitioning management, transitioning ownership, engaging in liquidity-creating transactions that do not involve the sale of your business and on.

In my new book, Unlocking Private Company Wealth, I talk about the time between now and your current status quo and the time of any ultimate sale of disposition of your ownership position in your business. The interim time, between now and any ultimate disposition, is the time we have to accomplish the things we know we need to do.

Rather than focus on this quarter’s earnings or subscriber growth announcement, you can focus during this interim time on some of the things that you can do to work towards enhancing the value of your business, developing liquidity from your investment, and creating independence from your business. You can think about and work on the ownership and management transitions that will occur while you have time and while you are in control.

So sit back, take stock, be relieved that your investors likely won’t trash your stock of you fall short on an estimate, and then get to work now, during the interim, so that you will be better-prepared in the event of any bad thing happening to your company. But more importantly, get to work so your company can become the wealth-creating vehicle you want it to be.

As I suggest in Unlocking Private Company Wealth (at p. 171):

Bad things happen to even good companies (link to post), possibly even yours.

If you are a business owner, you may be thinking that diversification is not a good thing. You are, indeed, focused on the one basket represented by your investment in your business. And indeed, you should be focused on that basket. You are ‘concentrate to create” wealth. But you may also need to begin to “diversify to protect” your wealth…

If you wait until it is too late to diversify, it will be too late.

That simple statement is powerfully true. As optimistic business owners, we tend to think that bad things happen, but to other people. So we wait to do things we know we should do. Financing that is readily available today to accomplish diversification objectives may not be available tomorrow. This can happen because of adverse events at your business, changes in the available of financing, or both. Don’t wait.

One Last Thought

Buy your copy of Unlocking Private Company Wealth. Buy additional copies to share them with your fellow owners, family, key management and advisers. It will open conversations that you need to have. One of the reviewers says in the front matter of the book:

I believe every family member owner, especially those who don’t work in their family’s business, needs to read Chris’ book. It is an excellent framework for understanding the importance of their investment and provides essential concepts to assist them in understanding and measuring for themselves the value of what is, for most, the largest asset in their investment portfolio. I plan on sharing it with our Family Council as a great educational tool for our family owners.

As always, please do comment on this blog. Or call me (901-685-2120) or email me (mercerc@mercercapital.com) to discuss any valuation-related matter in confidence. I am having an increasing number of conversations with business owners about issues related to ownership and management transitions.

Until next time, be well!

Chris