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Class Sues Netflix for 25 Percent Share Drop

SAN FRANCISCO (CN) - Netflix stock dropped by 25 percent in a day after analysts questioned its cheerful, and inaccurate, growth predictions, shareholders claim in a federal class action.

Click here to read Courthouse News' Entertainment Law Digest.

Lead plaintiff Martin Schulthes claims Netflix's share price dropped from $80.39 on July 24, 2012, to $60.28 per share the next day, after defendant CEO Reed Hastings' rosy outlook wilted under the heat of reality.

Netflix correlates its revenue growth largely to subscriber growth, according to the complaint.

In the first quarter of 2012, Netflix predicted it would add 7 million new subscribers for its domestic streaming segment by the end of the year, based on a growth trend that began in 2010.

On July 3, 2012, Hastings announced on Facebook that "Netflix monthly viewing exceeded one billion hours for the first time ever in June," according to the complaint.

"That announcement affirmed Hastings' statements of April 23, 2012 that the company was 'continuing to execute on all of the key dimensions' and 'everything was consistent with what we've been hoping for,' leading the market to believe that Netflix was on 'target for the year' to achieve the 7 million net additions in domestic subscribers," the complaint states.

On July 5, Netflix stock surged to $81.72 per share on almost 15 million traded shares, a 13.4 percent increase from $72.04.

But at least one analyst questioned the company's April 23 first-quarter earnings prediction.

The analyst asked Hastings: "Why are you so confident that gross add trends result from seasonality and not slowing growth? How can you be confident in 7 million net additions for the year?"

Hastings said he based his prediction on a "fantastic" first quarter of 2012, which added nearly 3 million subscribers.

"We had strong results in all of our territories, including the U.S.," Hastings replied, according to the complaint. "Our gross adds are consistent with our historic patterns. Our churn is consistent with our historic patterns, and we're feeling very good about the year."

On July 24, Netflix sent a letter to shareholders assuring them the company had "achieved financial performance in the top half of ... guidance in nearly every metric, and ... returned to profitability," according to the complaint.

But many were not persuaded.

"What was disconcerting to investors, however, was that the company had only 530,000 net subscription additions for its domestic streaming business, resulting in total domestic streaming subscriptions of 23.94 million," the complaint states. "The company also noted that it may not reach its target of adding 7 million domestic streaming subscribers by the end of the year."

Stocks dropped from $80.39 on July 24 to $60.28 per share the next day.

Schulthes claims Netflix misled investors: that Hastings and co-defendant CFO David Wells knew the company would report significantly lower growth than they had announced, that 7 million goal was not likely to be reached, that they "intentionally misrepresented the impact of the one billion hours of viewing on subscriber growth and those misrepresentations remained uncorrected during the class period."

Schulthes seeks class damages for violations of the Securities Exchange Act of 1934.

He is represented by Jorge Amador, with the Rosenfarb Law Firm, of New York City.

A federal judge last week dismissed a shareholder derivative complaint, filed in November 2011, that claimed the company wasted assets by spending more than $1 billion buying back shares at inflated prices.

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