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Hello,

I am new here and would like to introduce one stock for discussion:
Netflix (NFLX).

NFLX is currently valued at around $11 in the market.
It generated approx. $100 million in Free Cash Flow (annualized latest FCF). This figure will go down next year as the lower-priced subscribtion strategy that NFLX launched starts to kick in.

Despite Blockbuster, WalMart, and Amazon.com involvements in the online DVD rental business, NFLX position in the US is very strong (shown by the growing number of subscribers, revenue, and book value per share).

I use simple formula in my investing activities to evaluate risk-adjusted return I can get from investing in a security (equities as well as bond):
[(Probability of gain x possible value of gain)-(Probability of loss x possible value of loss)]/current value

This involves:
1. Calculation of the approximate intrinsic value of NFLX as the upper bound and the approximate liquidation value of Netflix as the lower bound (after considering the management competence and franchise value of Netflix)
2. Objective assessment of possibilities of gain and loss in %.

Please share your thoughts.

Thank you,
ValueCapital
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"Please share your thoughts.

Hi ValueCapital,

Since you just asked for thoughts I can do that. First its down from a high of just under $40 to $12 could signal a value play.... but then here's a P/E of 42... not much of a value in my mind. I think the coming year will be rough on overvalued stocks. The completion is just starting, Amazon and WalMart will likely take a fair share of the business... NetFlix lowered monthly fees... not good for the profit outlook... I think they had their moment in the sunshine so I 'm not interested but thats just my view of things... may be a winner but I'll be looking elsewhere. I know there are folks who like the company...

http://tinyurl.com/48rl2 for an article at CBSMarketwatch

Regards, Ken ("As Tim McGraw sings, "I hope you get the chance to live like you were dying.")

If you want a Spell Checker for InternetExplorer or Firefox to check MF posts or other web forms: IE => http://www.iespell.com or for Firefox => http://tinyurl.com/3pdwt
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>>I am new here and would like to introduce one stock for discussion:
Netflix (NFLX).<<

Personally, I think Netflix is attractive, but I don't own it.

The perplexing aspect is how fast this company grow into the future, and I think they will do fine. My belief is they likely have some pretty solid cost advantages over blockbuster. Amazon is the only difficult competitor in my view, and then they are just competitors.

VOD is a long term issue that they are building a strategy for, but that is a number of years out.

I believe there is a behavioral issue going on now in the stock - tax loss selling. Once year end hits, I'm guessing we should see a bounce because of that. Another in that same mold that I own is DSCM.
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Hi Matt1344,

Thank you for your comment.

What I see in NetFlix is a subscription-base business that is already running with some heavy competitions coming from Blockbuster, WalMart and Amazon (in UK).

I usually analyze a possible undervalued situation (stock and bond) using these:
1. Intrinsic value vs. current market value and the %-probability of stock or bond price rising to intrinsic value level.
2. Liquidation value vs. current market value and the %-probability of stock or bond price declining to liquidation value level.

For NFLX, I use simple FCF-multiple approach instead of the Discounted Cash Flow model since I can not reliably project the amount of Free Cash Flow and growth rate that NetFlix is able to generate in the next 12 months. I assume that NFLX will probably able generate only $60 million (in the next 12 months) compared to $134 million FCF that it was able to generate in the last annualized FCF data. I then assign FCF-multiple of 15 (DCF method afterall can be simplified into an Excel table that shows FCF multiple at given growth rate, competitive advatage period, and discount rate. The intrinsic value for NFLX using this simplistic method is: $900 million
Note: although this is not perfect, I am quite comfortable with the figure since:
- The FCF-multiple of 15 is actually conservative considering NetFlix' excellent market share, revenue, and cash flow performance for the past 3 years (despite the cloudy future that wall street sees in NFLX nowadays)
- NetFlix's # of subsribers is still growing rapidly (this is a fact we can not deny)/
- The CEO, Reed Hasting, understand the competitive situation as shown int the latest CBS article.
- Afterall, this company growth rate last year was around 78%. THis is a high-growth business.

To get the Liquidation Value of NetFlix, I simply calculated the latest Net Net Asset Value (NNAV) = Current Assets minus Total Liabilities =
$176 mill - $91 mill = $85 million.

Common-sense analysis:
1. Intrinsic value (IV) vs. current market value (MV) and the %-probability of stock price rising to intrinsic value level.
IV vs. MV = $900 million vs. $667.60 million.
%-probability it can reach $900 mill valuation within one year is approx. 90% (this is the figure I am confortable with after looking at NFLX financial statements, business model, market share & competition, website, and management/insiders ownerships + some mainstreet inputs).

2. Liquidation value vs. current market value and the %-probability of stock price declining to liquidation value level.
$85 million vs. $667 million.
%-probability it can go down to only $85 mill valuation is approx. only 10% (this is the figure I am confortable with. It is unlikely NetFlix will go down to $85 mill market valuation level -- this is below NFLX latest book value of $144.82 million).

Then I use this simple formula (following Warren E. Buffett's advice) to calculate the %-gain that NFLX can offer me as a value investor:
(Delta of Gain x Prob of Gain) + (Delta of Loss x Prob of Loss)
--------------------------------------------------------------- x 100%=
Current Market Value

(900 - 677.60)x 90% + (85 - 677.60)x 10%
= ---------------------------------------- x 100% =
677.60
177.92 - 118.2
= --------------- x 100% = 20.70%
677.60

To be more conservative, I can reduce the Prob of Gain to be 80% and Prob of Loss to be 20% in the above formula, and the result is psotive 8.76%.

I think NFLX's risk/reward ratio is good for long-term investor (at current market price)

What do you think?

Best Regards,
ValueCapital

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"I think NFLX's risk/reward ratio is good for long-term investor (at current market price)

What do you think?


Hi ValueCapital,

I can't disagree with you. This may be a good investment, just not one I will buy. Part of my lack of enthusiasm was brought on with the increasing competition and subsequent drop in subscriber rates. I think they will have to maintain good growth to keep investors happy in the next year or so.

It's not that I think they won't survive I just wonder how things will shake out in the long run. I also don't relate to the company on a personal level, I turned off my TV over 2 years ago and have never rented a movie.. When I want to see one I go to the theater. I have a friend who loves the service and they watch lots of movies.

I think it will be interesting to see if there's a major price war in order to gain/hold market share..

Regards, Ken
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>>For NFLX, I use simple FCF-multiple approach instead of the Discounted Cash Flow model since I can not reliably project the amount of Free Cash Flow and growth rate that NetFlix is able to generate in the next 12 months. I assume that NFLX will probably able generate only $60 million (in the next 12 months) compared to $134 million FCF that it was able to generate in the last annualized FCF data.<<

The message I got from listening to their last CC was that 60 mill is probably an overstatement. In the near term, given the competitive landscape, they seemed to want to focus on building subscribers and brand, while sacrificing most of the profits.

Analyzing this stock based upon near term free cash flow seems like a seriously flawed endeavor though. 2006, 2007, etc, are what really needs to be analyzed, as during any near term holding period, the market will try to discount the future. So if you can't come up with such a judgement, I'd pass on the stock - though I have a feeling you do have such a judgement, but it's not concrete. The future (albeit, fuzzy) is the appeal of the stock - not the next 12 months.

I think the reward for this stock is much greater than you layout. 20% would not be good enough to get me to jump at anything.
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ValueCapital

It generated approx. $100 million in Free Cash Flow (annualized latest FCF).

Would you share how you determined this? I get about $37M over the last 4Qs.....or about $.75/share.

PosFCF
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Hi PosFCF,

You are right.
I actually got the figure from Yahoo Finance Statistic data. I now think $100 mill FCF is an overstatement.

After looking at NFLX'latest qtrly financial report:
http://biz.yahoo.com/prnews/041014/sfth002_1.html
, NFLX seemed to be able to generate approx. 39 million in FCF (= 12/9 x 9-mo Non-GAAP FCF figure)

My previous prob. analysis then can be viewed as overstated. Still, NetFlix is running business. Anyone should notice how hard it is to actually start a business.

Best Regards.
ValueCapital
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Value Capital

Still, NetFlix is running business. Anyone should notice how hard it is to actually start a business.

And it is cash flow positive, which is even rarer. However, the question becomes is it a value?

An investor has to determine for themselves what they mean by the term "value". They don't necessarily have to re-invent the wheel, as it were, because there has been a lot of good thought put into answering that question. Benjamin Graham and David Dodd are two of the more reknown thinkers whose work has stood the test of time. But there are many others as well.

In your approach, I believe you use the Discounted Cash Flows (DCF) method of arrving at an approximation of intrinsic value and then probably want to buy at a discount to that.

I don't use that approach, but many do. What I've discovered over the years of frequenting the better message boards (like those found here on the Fool), is that there seem to be as many good approaches to value investing as there are good investors. No two good investors that I know have the exact same methodology for buying or selling.

I'm glad to see that you have taken the time to try to discover your methodology and also then taken the time to share it.

PosFCF
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Hi PosFCF,

It is true that investor can not just rely on few methods such as DCF method, book value, and liquidation value to derive a conclusion on a particular situation. Different investors value a stock differently. I believe and practice common-sense analysis that at least can provide more visibility for me as long-term value investor in term of approximating the upper bound and lower bound of a stock value. As such, I use integrative methods in analyzing a value play situation which can be as simple as using only DCF and Liquidation Value analysis tied with probability analysis to using varieties of soft analyses such as management, franchise value, instinct, etc. to even calling the management and the main customers and competitors of the company I am interested in.

In NetFlix case, the CEO, Mr. Hastings, has done enough (maybe a but too frequent) in explaining as much as he possibly know to the media (that is why some of the Wall-Streeters viewed that he changes his information many times). The fact is, in my opinion: he was just being candid on NetFlix's business operation. After all he owns 4,060,618 shares - NetFlix's largest individual shareholder. Proof: It turned to be right that Amazon.com launched a competing online DVD rental operation (in UK for now). Hastings knew this in advance and preemptively responded by lowering NetFlix's subscription price. He understands his company's competitive position and advantage.

I updated my original NetFlix's upper bound vs. lower bound with probability analysis below:

Upper Bound = Intrinsic Value = $40 million Non-GAAP FCF x 20 FCF-multiple = $1,000 million (vs. $667 million current market valuation)
%-probability it can reach $600 mill valuation within one year is approx. 90% (this is the figure I am comfortable with after looking at NFLX financial statements, business model, market share & competition, website, and management/insiders ownerships + some main street inputs).

Note: I am comfortable with this since I assume NFLX can:
- generate at least $40 million in FCF annually for the next 10 years despite the short-term bumps next 1-2 years (next year, it may be true that NFLX will generate $0 FCF due to heavy advertising and lower pricing strategy due to competition). I agree with GoodHindSite who said: "In the near term, given the competitive landscape, they seemed to want to focus on building subscribers and brand, while sacrificing most of the profits."
- grow 25% annually on average for the next 5-10 years in term of FCF. Hence, I use 25 as FCF-multiple (a bit simplistic, but this is not for P/E ratio)
-

Lower Bound = Liquidation Value = Net Net Asset Value = $85 million (vs. $667 million current market valuation)
%-probability it can go down to only $85 mill valuation is approx. only 10% (this is the figure I am comfortable with. It is unlikely NetFlix will go down to $85 mill market valuation level -- this is below NFLX latest book value of $144.82 million).

Then again, I use this simple formula (following Warren E. Buffett's advice) to calculate the %-gain that NFLX can offer me as a value investor:

(Delta of Gain x Prob of Gain) + (Delta of Loss x Prob of Loss)
----------------------------------------------------------------------------- x 100%=
Current Market Value

(1,000 - 677.60) x 90% + (85 - 677.60)x 10%
= ------------------------------------------------------- x 100% =
677.60
(289.89 - 118.2)
= ------------------------ x 100% = 25.34%
677.60


Btw, my previous reasoning that I stated in my previous posting still applies plus several new reasons:
- NetFlix has excellent market share, revenue, and cash flow performance for the past 3 years (despite the cloudy future that Wall Street sees in NFLX nowadays)
- NetFlix's # of subscribers is still growing rapidly (this is a fact we can not deny)/
- The CEO, Reed Hastings, 43 years old, understand the competitive situation as shown in the latest CBS article. He is also the largest individual shareholder of NetFlix with 4,060,618 shares.
- After all, this company growth rate last year was around 78%. This is a high-growth business and a high-growth niche sector.
- Legg Mason Inc. owns 6,065,700 shares which were bought at $11.58/share ($93,533,092), reported on 30-Sep-04.  Bill Miller, Legg Mason chief, is legendary for his value picks.
- NetFlix has a great brand name and recognition among internet users.
- I agree with Hastings that for Wal-Mart and Amazon.com, online DVD rental is just a small piece of their overall business operations and hence the company that stands to lose the most will be Blockbuster (which now is busy to acquire Hollywood Entertainment and has brick-and-mortar presence embedded within its operating cost structure).

I still think NFLX now provides good risk/reward ratio for long-term investor at the current price of <$13.

What do you think?

Best Regards,
ValueCapital
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Updated due to typo.
Hi PosFCF,

It is true that investor can not just rely on few methods such as DCF method, book value, and liquidation value to derive a conclusion on a particular situation. Different investors value a stock differently. I believe and practice common-sense analysis that at least can provide more visibility for me as long-term value investor in term of approximating the upper bound and lower bound of a stock value. As such, I use integrative methods in analyzing a value play situation which can be as simple as using only DCF and Liquidation Value analysis tied with probability analysis to using varieties of soft analyses such as management, franchise value, instinct, etc. to even calling the management and the main customers and competitors of the company I am interested in.

In NetFlix case, the CEO, Mr. Hastings, has done enough (maybe a bit too frequent) in explaining as much as he possibly know to the media (that is why some of the Wall-Streeters viewed that he changes his information many times). The fact is, in my opinion: he was just being candid on NetFlix's business operation. After all he owns 4,060,618 shares - NetFlix's largest individual shareholder. Proof: It turned to be right that Amazon.com launched a competing online DVD rental operation (in UK for now). Hastings knew this in advance and preemptively responded by lowering NetFlix's subscription price. He understands his company's competitive position and advantage.

I updated my original NetFlix's upper bound vs. lower bound with probability analysis below:

Upper Bound = Intrinsic Value = $40 million Non-GAAP FCF x 25 FCF-multiple = $1,000 million (vs. $667 million current market valuation)
%-probability it can reach $600 mill valuation within one year is approx. 90% (this is the figure I am comfortable with after looking at NFLX financial statements, business model, market share & competition, website, and management/insiders ownerships + some main street inputs).

Note: I am comfortable with this since I assume NFLX can:
- generate at least $40 million in FCF annually for the next 10 years despite the short-term bumps next 1-2 years (next year, it may be true that NFLX will generate $0 FCF due to heavy advertising and lower pricing strategy due to competition). I agree with GoodHindSite who said: "In the near term, given the competitive landscape, they seemed to want to focus on building subscribers and brand, while sacrificing most of the profits."
- grow 25% annually on average for the next 5-10 years in term of FCF. Hence, I use 25 as FCF-multiple (a bit simplistic, but this is not for P/E ratio)
-

Lower Bound = Liquidation Value = Net Net Asset Value = $85 million (vs. $667 million current market valuation)
%-probability it can go down to only $85 mill valuation is approx. only 10% (this is the figure I am comfortable with. It is unlikely NetFlix will go down to $85 mill market valuation level -- this is below NFLX latest book value of $144.82 million).

Then again, I use this simple formula (following Warren E. Buffett's advice) to calculate the %-gain that NFLX can offer me as a value investor:

(Delta of Gain x Prob of Gain) + (Delta of Loss x Prob of Loss)
----------------------------------------------------------------------------- x 100%=
Current Market Value

(1,000 - 677.60) x 90% + (85 - 677.60)x 10%
= ------------------------------------------------------- x 100% =
677.60
(289.89 - 118.2)
= ------------------------ x 100% = 25.34%
677.60


Btw, my previous reasoning that I stated in my previous posting still applies plus several new reasons:
- NetFlix has excellent market share, revenue, and cash flow performance for the past 3 years (despite the cloudy future that Wall Street sees in NFLX nowadays)
- NetFlix's # of subscribers is still growing rapidly (this is a fact we can not deny)/
- The CEO, Reed Hastings, 43 years old, understand the competitive situation as shown in the latest CBS article. He is also the largest individual shareholder of NetFlix with 4,060,618 shares.
- After all, this company growth rate last year was around 78%. This is a high-growth business and a high-growth niche sector.
- Legg Mason Inc. owns 6,065,700 shares which were bought at $11.58/share ($93,533,092), reported on 30-Sep-04.  Bill Miller, Legg Mason chief, is legendary for his value picks.
- NetFlix has a great brand name and recognition among internet users.
- I agree with Hastings that for Wal-Mart and Amazon.com, online DVD rental is just a small piece of their overall business operations and hence the company that stands to lose the most will be Blockbuster (which now is busy to acquire Hollywood Entertainment and has brick-and-mortar presence embedded within its operating cost structure).

I still think NFLX now provides good risk/reward ratio for long-term investor at the current price of <$13.

What do you think?

Best Regards,
ValueCapital
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ValueCapital

What do you think?

Whew! Surely is a lot to digest for this old redneck!

I updated my original NetFlix's upper bound vs. lower bound with probability analysis below:

I usually only have one criteria: "Does it offer a margin of safety today?". But, like I said, I'm just a simple redneck so I'd just get all tangled up if I tried probability analysis and integration and stuff like that. Heck, I get confused goin' for the mail sometimes! <GGGGG>

To expand on my standard, I look at the cashflow compared to the price and ask myself the question: "If they did next year what they did the last 4 quarters, would I be a happy owner buying in at this price?"

I like keeping it simple enough for me, and no doubt, as bright as you sound, what you do is simple enough for you to do.

Lower Bound = Liquidation Value = Net Net Asset Value = $85 million (vs. $667 million current market valuation)
%-probability it can go down to only $85 mill valuation is approx. only 10% (this is the figure I am comfortable with. It is unlikely NetFlix will go down to $85 mill market valuation level -- this is below NFLX latest book value of $144.82 million).


I used to buy based on liquidation value and sometimes still do. Figuring out liquidation value isn't of much use though if you don't believe the number or don't believe you'll use it.

After all he owns 4,060,618 shares - NetFlix's largest individual shareholder.

While I guess that's important to some, I don't know how much extra confidence that really gives me. Let's face it, he didn't buy those shares on the open market paying full retail for them. He likely got the lion's share through the IPO and then through options and stock grants. The theory is that if the CEO owns a lot of shares that somehow he'll be able to have performance abilities he doesn't possess without that ownership. A person of character will perform well in either case and I only want to own companies run by people of character.

I still think NFLX now provides good risk/reward ratio for long-term investor at the current price of <$13.

Well, that's important. An investor should have enough confidence in their analysis to be comfortable when they have their money invested.

It seems like it has good, but not great, numbers to me.

Good Luck with it!

PosFCF
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" He likely got the lion's share through the IPO and then through options and stock grants.

Hi PosFCF,

I'd be surprised if any of it was acquired during the IPO. Heck, that's when they like to sell off some. I don't know his history with the company but if he's one of the founders you can be pretty sure he got it well under the IPO price, at least that's how it worked in the few startups I worked for. One co I worked at let us(regular employees) buy stock at $12.25 with a one year lock up. Just before going public at $22, they split 5:1. At another start up the founders paid 10¢ per share, I got to buy some at $1... Never went public but did end up paying me back $%.28 per share from royalty income after they went out of business.

Regards, Ken
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"I like keeping it simple enough for me, and no doubt, as bright as you sound, what you do is simple enough for you to do."

I use the simple probability formula that is inherently not as simple as it looks and can give investor (at least me) a better view to navigate the risk/reward profile of a situation. Despite its simplicity, I belive this formula is strong enough (provided that the data is right) as a tool to decide whether a particular stock is a good candidate for investment.

As for NFLX, I view Blockbuster latest strategy as a flawed one.

"The generous policy is forecast to wipe out $250 million to $300 million in 2005 operating income, along with another $50 million tied to marketing expenses. Much of this should be offset by increased rental transactions (a trend already under way in markets where the new policy is being tested)."
-- taken from Fool.com article on Monday, Dec 14, 20004.

I think if both NetFLix and Blockbuster are losing money next year, on % basis compared to their Assets, BBI most likely will lose much more.

I questioned the ability of Blockbuster which has more than 4,500 stores in the United States, to recover the income (and operating cash flow) it will lose when it eliminates late fees. Their new strategy is a bit silly: Under the new Blockbuster plan, a customer will have a one-week grace period after a rental due date. If a movie or game is not returned during that week, it will be automatically sold to the customer. If the item is then returned within 30 days, the customer can get a credit to his account. The rental chain is betting on increased rental transactions and retail sales to offset the lower level of revenue resulting from eliminating late fees. In my opinion, this shows how strong NetFlix competitive force is in the online DVD rental. Also, it shows that NFLX has been successful in executing their lower pricing strategy and gaining new subscribers (many used to be Blockbuster's customers):
"The plan to run lean to add subscribers as fast as possible seemed to be working -- the company recently raised subscriber guidance for the current quarter from 2.4 million to 2.55 million. Hastings said the company will reach its goal of 4 million subscribers by the end of 2005 despite "a pretty massive assault" from Blockbuster."
-- taken from CBS Article on Friday, Dec 10, 2004

Other points:
- According to The NPD Group market research firm, as of December 2003, about 63% of all U.S. households had a standalone DVD player. In addition, Paul Kagan Associates estimated that consumers in the United States spent $25.6 billion on home video and theatrical filmed entertainment in 1999 and has forecasted this spending to grow to $35.0 billion in 2004.
- Netflix almost doubled the number of distribution locations in 2003 and now has over twenty shipping centers nationwide.
- As of the end of 2003, Netflix's subscriber base had grown 74% year over year to 1,487,000 in total from 857,000 total subscribers at the end of 2002. The company's subscriber base also grew 15% sequentially from 1,291,000 total subscribers at the end of the third quarter of 2003.
- Netflix's goal is to attain a subscriber base of 5% of the total households in the U.S. Based on its current momentum and shipping center expansion program, the company believes it can attain that goal and generate $1 billion in annual revenues by the 2006-2007 time frame.
- Netflix has doubled its subscribers to more than two mln in the past year, and predicts it will end 2004 with about 2.7 mln. Netflix has captured about 90% of the market for renting online DVDs.

Best Regards,
ValueCapital
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Legg Mason Inc. owns 6,065,700 shares which were bought at $11.58/share ($93,533,092), reported on 30-Sep-04.  Bill Miller, Legg Mason chief, is legendary for his value picks.

Hello ValueCap,

Where did you get the average purchase price of $11.58? You are certain that it is correct?

Best Regards,

Adren
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I got it from Yahoo! Finance insider holding.

ValueCapital
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Hi Adren,

Correction: It is that Legg Mason bought NFLX at $11.58 per share buying price. Legg Mason owned 11.58% of the NFLX.

I got it from Yahoo! Finance's major holder page of NFLX:
http://finance.yahoo.com/q/mh?s=NFLX
This page shows that:
Legg Mason Inc. owns 6,065,700 shars, 11.58% stake in NFLX, valued at $93,533,092 as of 30-Sep-04.

ValueCapital
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Adren,

Correction: It is that Legg Mason bought NFLX at $11.58 per share buying price. Legg Mason owned 11.58% of the NFLX.

I got it from Yahoo! Finance's major holder page of NFLX:
http://finance.yahoo.com/q/mh?s=NFLX
This page shows that:
Legg Mason Inc. owns 6,065,700 shars, 11.58% stake in NFLX, valued at $93,533,092 as of 30-Sep-04.

ValueCapital


Ok that clears it up, I was wondering about that because it would be excellent to know average purchase prices of major holders, although I can see why they would not want to disclose them.

Adren
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It is that Legg Mason bought NFLX at $11.58 per share buying price. Legg Mason owned 11.58% of the NFLX.

Legg Mason Inc. owns 6,065,700 shars, 11.58% stake in NFLX, valued at $93,533,092 as of 30-Sep-04.


The 'valued at' portion of this statement only tells you the value of the shares held...not their cost basis as previously mentioned.

there value per share might have been $11.58 on SEPT 30, but this is not their average price.

Legg Mason very likely paid more than $11.58 per share.
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