They're Wrong About Netflix

Wall Street is turning on Netflix (Nasdaq: NFLX  ) .

Analysts at Bank of America, Susquehanna Financial, and Kaufman Bros. are downgrading shares of the movie-rental specialist this morning.

It's a dangerous place to be -- for the analysts.

Betting against Netflix has been hazardous to the performance of Wall Street's pros.

A history of analytical failure
Back in mid-January, Lazard Capital Markets' Barton Crockett downgraded the stock, fearing that the service's year-end subscribers had clocked in at the low end of the company's guidance of 12 million to 12.3 million accounts.

He was wrong. Two weeks later, Netflix blew past analyst's fourth-quarter guesstimates, closing out the year at the highest end of its range with 12.3 million subscribers. It's dangerous to bet against the flick flinger so close to an earnings report since Netflix has bested Wall Street targets in each of the past seven quarters.

January's blowout quarter won it several analyst upgrades after the fact, including a move from "neutral" to "buy" from Merriman Curhan Ford.

I'm singling out that call, because Merriman Curhan Ford had downgraded the stock -- from "buy" to "neutral" -- nearly two months earlier. What did Netflix shares do between Dec. 1, 2009, and Jan. 28, 2010, as the analyst had turned on the company? Well, the stock rose 8% -- during a nearly two-month span that found the S&P 500 inching slightly lower.

Be kind and rewind
Netflix hit an all-time high yesterday, meaning that every analyst with a previously bearish or lukewarm opinion on the stock has missed. It happens. No analyst is perfect. The jury is naturally out on how this morning's downgrades will pan out over time.

The real doozy comes from Bank of America's Nat Schneider, taking the stock down from "buy" to "underperform" without a pit stop at "neutral" along the way.

Schneider feels that Time Warner's (NYSE: TWX  ) HBO Go is a significant new threat to Netflix's dominance on the streaming front. He's wrong about that. He also believes that the service's subscriber base would have to triple in five years to justify the current price. He's wrong about that, too.

Let's tackle HBO Go first. When Time Warner helped launch the TV Everywhere initiative, the plan was to make cable subscriptions more attractive by allowing customers to stream as much of the content that they are already paying for as possible.

HBO Go is impressive, offering up hundreds of HBO shows, specials, documentaries, and even some movies for online streaming. It's hard to knock HBO's content, but it's only available for couch potatoes who are paying for HBO on top of their costly cable or satellite television subscriptions. You can't compare someone paying $80-$100 a month for premium cable to the $8.99 Netflix subscription that offers unlimited digital delivery (as well as fresher releases on DVD).

HBO Go will be an important retention tool, but it's not going to get in the way of Netflix's compelling value proposition.   

It's a long way out to 2015
Schneider's valuation argument is incomplete.

It's true that Netflix isn't exactly cheap these days. It closed yesterday at 28 times this year's projected profits and 22 times next year's estimate. It's comforting to know that analysts have done nothing but underestimate the company's actual earnings power over the past two years (so those multiples are probably inflated), but bearishness itself isn't a problem.

Assuming that Netflix's subscriber base will have to triple by 2015 to justify today's price, on the other hand, is a little nutty.

Let's go back five years, before shooting ahead to 2015. Digital streaming wasn't in the company's playbook. Netflix was simply building out its physical distribution centers, with Blockbuster (NYSE: BBI  ) and Wal-Mart (NYSE: WMT  ) as its only real competitors.

It's an entirely different marketplace today. It marginally competes for real-world DVD rentals from Blockbuster and Coinstar's (Nasdaq: CSTR  ) Redbox kiosks, while it stands alone in digital delivery. Apple (Nasdaq: AAPL  ) , Amazon.com (Nasdaq: AMZN  ) , and even Blockbuster are selling digital downloads and rentals, but none of them offer the unlimited spread that Netflix includes at no additional cost to its DVD plan subscribers.

If the Netflix model and competitive landscape have changed so dramatically from 2005 to 2010, why won't it be altered materially come 2015? International expansion is on the horizon. It's just a matter of time before Netflix follows Blockbuster and GameFly into video game rentals. As a cash-rich company, Netflix may very well acquire incremental revenue streams along the way.

In short, there are plenty of potentially positive catalysts to keep Netflix relevant, growing, and perpetually humbling the prognosticators. That final point is important. Betting against Netflix in the past hasn't paid off for bearish analysts. This morning's skepticism is likely facing a similar fate.  

Is Netflix overvalued or undervalued? Share your thoughts in the comment box further down this page.

Apple, Amazon.com, and Netflix are Motley Fool Stock Advisor selections. Wal-Mart Stores is a Motley Fool Inside Value recommendation Try any of our Foolish newsletter services, free for 30 days.

Longtime Fool contributor Rick Munarriz has been a Netflix subscriber -- and shareholder -- since 2002. He is part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 03, 2010, at 1:59 PM, seethruU wrote:

    Rick...it's so funny to see you on the defense!

    Better scramble some more big boy! Let's see what happens with the post office going to 5 days a week! Is 12 million a true number? Can that be sustained? We'll see

  • Report this Comment On March 03, 2010, at 2:10 PM, BioBat wrote:

    12 million subscribers is really not that big of a number when you consider that's only about 10% of US households - there's plenty of room to grow, especially amongst PS3 and Wii users who want to stream video over the web directly to their TVs.

    $9 is also a price point that no one else seems to be able to beat. I don't worry so much about the ability of Netflix to keep and bring in new subscribers - I worry about the ability of cable companies to retain theirs.

  • Report this Comment On March 03, 2010, at 2:10 PM, BioBat wrote:

    12 million subscribers is really not that big of a number when you consider that's only about 10% of US households - there's plenty of room to grow, especially amongst PS3 and Wii users who want to stream video over the web directly to their TVs.

    $9 is also a price point that no one else seems to be able to beat. I don't worry so much about the ability of Netflix to keep and bring in new subscribers - I worry about the ability of cable companies to retain theirs.

  • Report this Comment On March 03, 2010, at 2:22 PM, feldmail wrote:

    These downgrades were classic "anal" lyst action. Witness the current price of $67.50 despite a low on the day of $65.62! Tripling subs by 2015 is not required for NFLX to maintain its share price. There is a hidden bonus as we move to more digital that no one is focusing on. Netflix is currently paying $600M in postage alone. That's over $10/outstanding share. If subs were to grow at only 15% over the next 5 years and streaming were to replace 50% of the DVD, there would be a windfall of $5/share to the bottom line!! Their European service will be streaming only.

  • Report this Comment On March 03, 2010, at 2:41 PM, FoxValley2012 wrote:

    There isn't a similar product offering to Netflix. HBO, Amazon, Hulu aren't the same--and certainly not at 9 bucks a month.

    Meanwhile, Netflix continues to increase it's ability to stream through Blueray players, built in on TVs, Wii, etc.

    We can all see that within a few years it will be all streaming. No DVDs, no mail, none of that. Everyone is trying to catch up to Netflix at this point. If Netflix stays ahead on the technology, content and a good price point, they are the winners.

  • Report this Comment On March 03, 2010, at 3:23 PM, joedodo2 wrote:

    I have followed Netflix for quite a few years and I haven't seen a model like it. Where can you spend $9.00 a month for unlimited downloads of older movies and one newer DVD at a time. I would pay twice this amount for the same service. I believe Netflix and CSTR will be head and shoulders above all other entertainment producers for the low and middle income people. I have stock in both companies. I hope netflix will stream newer DVD's in the future of course at a price increase. It will still be cheaper than the current market that is charging $4.99 to 1.99 per download.

  • Report this Comment On March 04, 2010, at 12:18 PM, dojodan444 wrote:

    No one is on Netlix's jock more than the FOOLS - LOL, they've got nowhere to go but DOWN.

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