Netflixation

posted 12.6.2010

As Netflix stock made new highs over the past couple of weeks and then retraced its steps, it's a stock price tug of war with the NFLX bulls and bears duking it out...

The Bulls
Morgan Stanley analyst Scott Devitt re-iterated his "overweight" rating on NFLX shares today, citing that Netflix's price plan increase on Nov 22 was justified because it has a "sustainable competitive advantage" due to four factors:

1. significant lead in Netflix-enabled streaming platforms
2. unrivaled content available for streaming
3. best-in-class streaming technology/architecture
4. iconic brand in streaming video

Mr. Devitt states that Netflix's scale, value, consistent execution will position it as a long-term prospect to benefit from the growth of digital video.

The article also points out that Amazon.com is developing a Netflix-like subscription service that offers streaming video for movies and TV shows and would be bundled with its Amazon Prime shipping service (currently $79/year).

> Read the Wall Street Journal article

Netflixation Perspective: It is not clear to us why Amazon.com would bundle a subscription-based streaming video service with its premium shipping service. More importantly, we believe that the points made by the Morgan Stanley analyst have already been discounted by the stock market, as NFLX closed at $193.47 today.

The Bears
In contrast, a well-known short seller Manual Asensio, CEO of Mill Rock LLC, said to CNBC on Friday that Netflix is "never going to make what the analysts are saying they're gonna make in 2013. It's just not a reality, it's a complete fiction." Mr. Asensio does not believe that in three year's time, Netflix will make $600M. While the analyst are projecting $400M to just shy of $600M, Mr. Asensio asserts the following fallacies and myths:

1. Subscriber level and churn: In order to achieve the earnings target, Mr. Asensio states that Netflix would have to attain 40 million subscribers, and asserts that in order to reach this level, Netflix would have to go through 65 million subscribers, given the expected churn rate.
2. Netflix subscriber account piracy: One subscription can be shared by many users, and this would potentially undermine Netflix's ability to reach its target number of subscribers.
3. Internet streaming video and bandwidth: Mr. Asensio points out that the internet is owned privately [by the likes of Comcast and internet providers will not allow unlimited streaming forever without usage fees].
4. Netflix selection engine: Mr. Asensio asserts that it is worthless.
5. The studios: streaming content deals like Epics and Starz are not exclusive [and these licenses will not last forever, as they are subject to re-negotiations].

Mr. Asensio asserts that as Netflix transitions from the DVD rentals-by-mail business, which he refers to as a "physical delivery of a physical product" to a streaming video model, Netflix is "struggling to survive". Netflix would have to spend on the order of $1B on content licensing deals, while currently pulling in only $150M in earnings. He believes that Netflix would not be able to meet its earnings target for 2013, and therefore NFLX is currently overvalued by a factor of four or five.

> Read the Barron's article (with the CNBC video segment)

Netflixation Perspective: Mr. Asensio did not acknowledge Netflix's prospects into international markets, as they did with Canada last month. We do not agree with him on the Netflix recommendation engine as we found many good movies that way. While many are not available for instant streaming (~20,000 titles), all titles (~100,000 titles) are available on DVD. On the other hand, he does have valid points about subscriber level and churn, Netflix account piracy, internet bandwidth concerns over streaming video, and the content deals. In order to make lucrative content deals with Hollywood, the company is likely to leverage using debt. As a side note, we think Mr. Asensio would have better credibility if he was more objective and gave credit where credit was due. He went over the top when he said the Netflix deal with Epics is "nothing" and that such content is available over the internet everywhere.

Rebuttal from the Bulls
Rick Munarriz of The Motley Fool attempts to rebutt Mr. Asensio's claims in this The Motley Fool article. While his facts are useful, we believe the market already discounted that in the stock price.

Netflixation Perspective: With a market capitalization of $10B and a stock price having increased nearly four fold in 2010, the stakes are high. Our gut feel is that the stock may have gotten ahead of the company. At the end of the day, we will have to crunch a few numbers on our own.

Netflixation Disclosure: In the interest of full disclosure, we at Netflixation have not bought any shares of NFLX, yet, at the time of this post. Long or short.