More on Netflix

October 29, 2011 at 10:13 pm Leave a comment

Well, the last three months certainly have been eventful for Netflix.  As of now, the stock is only worth about a quarter of what it fetched back in July.  The latest nail was struck after the quarterly report when the company warned that it might be unprofitable in 2012 due to the costs of international expansion.  Reed Hastings went from the being the smartest CEO to apparently the dumbest.  A number of articles appeared in financial press claiming that Netflix streaming model is unsustainable and predicting company bankruptcy (!) within a year.

Without a doubt, PR around recent price hike and the whole Qwikster debacle could have been handled better.  But what has really changed?  The 800,000 subscribers lost during the last quarter is a big number — but Netflix still has 24 million subscribers who apparently value the service even after the price increase.  Starz decided not to renew its streaming deal, but Netflix signed up a number of other studios instead.  Finally, Netflix could show good profits next year, but instead it chose to use the funds to invest in growing the business by international expansion.  Does all of this really deserve 75% haircut?

Well, of course it is debatable whether $300 price tag was justified in the first place.  Looking back at stock price history, a very similar drop happened before, back in 2004.  Then, Netflix had to lower prices to fend off Blockbuster’s Total Access program, and the stock promptly tanked from over $40 to just below $10 — a 75% drop.  For 5 years after that, the stock price was stuck in a trading range between 15 and 30, and it took off with a vengeance in 2009.

I believe that we could be in for a similar trading range for the next several years.  Currently, the stock is cheap based on fundamentals, such as price-to-sales ratio.  Also, any number of cash-rich companies, for example, Amazon, Apple, Microsoft, Google, etc. could acquire the company with minimal impact on their cash position.  This should provide support for the stock.  On the other hand, I don’t see any catalysts to propel the stock forward in the near future.  The prospect of unprofitable 2012 will certainly make short-term oriented Wall Street analysts to talk down the stock and this will put a lid on meaningful appreciation.

Can Netflix reach $300 again?  I think it is very possible, if the company can still attract U.S. subscribers and if it is successful in its international expansion.  I think that current price levels present an excellent opportunity to long-term oriented and patient investors.

Entry filed under: Stock Ideas.

Worst Quarter since 2009 Market Update

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Blog Author

Leon Shirman's long-term investment philosophy is summarized in his book, “42 Rules for Sensible Investing”, also available from Amazon.


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