Netflix's (
NFLX
) stock has fallen since its July 2011 levels of approximately $300
and has left investors with a bitter taste in their mouth. The last
two years have transformed Netflix from a mainstream DVD rental
provider to an online movie streaming leader, ahead of relative
newcomers such as Amazon (
AMZN
), Dish Network's (
DISH
) Blockbuster and Comcast's (
CMCSA
) Xfinity Streampix. However, management's poor decisions and
communication regarding pricing and product changes have left
Netflix struggling with subscriber defections.
Our current price estimate for Netflix stands at
$96
, implying a premium of about 50% to the market price. Our thesis
is centered around Netflix's lead in streaming domestically and its
international prospects.
See our complete analysis for Netflix
Image Re-Building In Process, Streaming Subscriber Gains
Have Begun
Netflix's U.S. quarterly subscriber additions, which grew 61% in
2010 and 255% in early 2011, started to decline when the
company announced a price increase and a re-branding of its DVD
business to Qwikster. Since then Netflix has been making efforts to
re-build its image and turnaround its subscriber trends. As a
result, first half of 2012 saw healthy streaming subscriber
additions when Netflix gained close to 2.27 million streaming
subscribers in the U.S. alone.
The company's long-term vision is to transition to a
pure-play streaming company and investors need to watch out
for competition in streaming arena rather than worry about DVD
declines.
Netflix commands close to 25% share of roughly 85 million U.S.
broadband households and about 20% share of the U.S. pay-TV
households. This implies a significant reach and given the early
mover advantage, an opportunity to expand further.
Content Advantage is Still High
Despite the setbacks in 2011, Netflix still enjoys a significant
competitive lead over some of the similar services such as Amazon
Prime and Blockbuster's streaming service.
Netflix has a much better online streaming library compared to
these competitors and has been consistently striking deals to
enhance its offering. Bigger competitors such as Amazon and Dish
will still have to work hard to catch up with Netflix. In fact,
Dish Network confessed during one of its earnings announcement that
making content deals has been a challenge for the company. We
think that given the content advantage that Netflix has, it will be
able to sustain subscriber growth in the U.S.
International Prospects Are Undervalued
We estimate that the international streaming business accounts
for about 25% of our price estimate for Netflix. We believe the
market is not fairly valuing Netflix's prospects in international
markets perhaps because of high content costs that the company will
have to incur for several more quarters, low per capita income and
low credit card usage in Latin America, and a limited market size
in Canada. In addition, investors are worried about competition in
some of these markets, particularly in the U.K.
On the contrary, we believe that Netflix has a fair chance of
success as initial results have been good. Netflix now has close to
3.6 million international subscribers out of which roughly 1.8
million were added in first half of 2012 alone. This demonstrates
that momentum is picking up in international markets. The broadband
penetration in Latin America, although low, is on the rise and the
market potential is huge. DirecTV's success in Latin American
markets such has Brazil demonstrates that advanced services such as
Netflix's movie streaming have a high probability of gaining
adoption in the region. Additionally, the company is looking to
launch in another undisclosed international region at the end of
2012, thus expanding its coverage beyond the U.S, U.K., Ireland,
Canada and Latin America.
Key Risks: International Failure, Competition
Intensifying, Content Costs Soar
One of the primary risks to our price estimate is the
possibility of international expansion slowing. Although we remain
optimistic about these geographies, there is a possibility that
Netflix does not gain traction in these regions. Stiff local
competition in the U.K. as well as low per capita income and lack
of credit card usage in Latin America could potentially slowdown
Netflix's international expansion significantly. We estimate that
such a slowdown could have a negative impact of about 20% to our
price estimate due to low international streaming subscriber
growth. The slowdown will not only affect subscriber gains, but
also the company's potential profitability in these regions.
Furthermore, if Amazon and Dish really throw their weight into
streaming and other competitors such as Verizon take on Netflix in
the domestic market, the ensuing content bidding war could have a
two-fold impact on Netflix. First, it will lead to higher content
acquisition costs causing margins to shrink. Second, it would lead
to content diversification, thus eroding some of the content
advantage that Netflix currently has. This could lead to a slowdown
in the company's expansion in the U.S. market. Such a scenario
could add another 20% downside to our current price estimate.
Understand
How a Company's Products Impact its Stock Price at
Trefis