End of the Line for Netflix?

Either way you look at it, Netflix (Nasdaq: NFLX  ) is heading south.

Shares of the rapidly growing video provider hit a new-all time high yesterday, announcing a bold southward expansion of its disc-less streaming service. Merriman Capital analyst Eric Wold doesn't think that's the only way that Netflix is going south of the border: Wold is downgrading shares of Netflix, from "buy" to "neutral," on valuation concerns given the recent run.

Yes, Netflix has been dazzling from most starting points. The stock is trading 65% higher so far in 2011, having nearly tripled over the past year. If you go all the way back to when the shares bottomed in the teens three years ago, you'd be looking at a 16-bagger.

The fundamentals have largely held up their end of the bargain. Netflix continues to tack on subscribers at a frenetic pace. There are now 22.8 million domestic subscribers, including 0.8 million streamers in Canada, where Netflix wasn't even available last summer.

Itinerary adjustements
I should point out that Wold doesn't necessarily believe that shares of Netflix will be literally heading south. He just sees limited upside at this point, given his target valuation range of $300 to $330. This isn't a reasonable return on a risk-adjusted basis, given a stock that's trading for more than 40 times next year's projected profitability.

Wold points to Redbox parent Coinstar (Nasdaq: CSTR  ) as an attractive replacement. I disagree. It certainly may seem to be a worthy antidote on a valuation basis, since Coinstar is trading at a forward earnings multiple in the mid-teens, a third of Netflix's number. But the Coinstar thesis crumbles after that.

Valuation concerns aside, I'm confident that Netflix will be a bigger and more relevant company in three to five years. Can the same be said about Coinstar? DISH Network (Nasdaq: DISH  ) recently tweaked the pricing strategy at the Blockbuster stores still standing, closing in on Redbox-esque value for shorter rentals. NCR (NYSE: NCR  ) continues to bank on its Blockbuster Express kiosks.

Then we get to concerns about the media itself. DVDs are following CDs into obsolescence in this age of digital distribution, and Netflix is leading the charge away from physical media, choosing to expand through only its streaming plan.

What's Coinstar doing to keep up? It's been promising a digital strategy since last summer, but it's been firing blanks. The chatter last year was that it would team up with a major player -- Amazon.com (Nasdaq: AMZN  ) or Wal-Mart (NYSE: WMT  ) seemed the likely partners -- but that seems unlikely now. Wal-Mart is still lost when it comes to digital distribution, and Amazon appears to want to go it alone.

Netflix certainly isn't cheap, but that doesn't mean that Coinstar, looking out a few years, isn't expensive.

The new truths about Netflix
I can't knock Wold's caution the way I have with other skeptics who turned bearish at much lower price points. For now, he may have nailed the near-term top.

I have been rewarded as a Netflix shareholder in recent years, but I, too, am feeling a bit hesitant about where the shares are heading over the next few months. The future won't mirror the past. The stock isn't going to pop another 65% during the second half of the year, and Netflix certainly isn't going to triple by next summer.

The next few quarters will be challenging, especially on the bottom line. Netflix has already made it clear that overseas expansion won't come cheap, and that opens the door for sloppy profitability despite what should be solid top-line gains.

However, Netflix is also in a unique position these days. People aren't worried that Netflix will be rubbed out in the digital revolution, the way they were when the stock was meandering in the teens on the other side of this recession. Netflix is now the proprietor behind the digital service that consumers can't live without and that Hollywood can't ignore.

Is Netflix overvalued or undervalued? Share your thoughts in the comments box below.

The Motley Fool owns shares of Wal-Mart. Motley Fool newsletter services have recommended buying shares of Wal-Mart, Netflix, Amazon.com, and Coinstar, buying puts in Netflix, and creating a diagonal call position in Wal-Mart. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. 

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


Read/Post Comments (4) | Recommend This Article (14)

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 July 06, 2011, at 6:19 PM, jkellynewyork wrote:

    I think it is fairly valued. Netflix, in addition, to spreading out globally, can still unlock tremendous value by offering premium rentals, or buy now for locker storage, and could probably get better deals by putting longer windows on discs.

    Totally agree with you on Coinstar -- do not see how Redbox could obtain any relevance in streaming given the competition, and investors are not looking long term to see that Redbox revs are not sustainable based on old tech

    Lets Go ZIP!!

  • Report this Comment On July 06, 2011, at 10:31 PM, heliski49 wrote:

    NFLX reminds me of AOL. Great product but nothing to stop competition from content providers from streaming their own stuff.

  • Report this Comment On July 07, 2011, at 2:53 PM, David369 wrote:

    @heliski49

    Yeah, content providers could stream their own stuff...ain't gonna happen. They aren't set up for it and it is not really in their interest to do so. That's sort of like saying the butcher could open a restaurant and sell all his steaks there for more. Easier for content providers to just sell to Netflix or whoever for a total cost or per view/account and be done with it.

    As long as NFLXs "sloppy profitability" stays profitable through their world domination. I'm happy.

  • Report this Comment On July 08, 2011, at 12:22 AM, blissmanna wrote:

    As a both a Netflix consumer and shareholder I see at least another 30% increase if, and only if, Netflix swings a few new content deals that truly keep the product attractive to subscribers.

    There is no way the Coinstar redbox could ever catch up or even stay as close as they are to Netflix popularity... Netflix is just to darned easy, automatic payment deduction from my checking account is easy... in and out mail is easy... streaming is easy. Browsing for content, reviews, viewing history...all easy.

    Here is the real kicker that will keep Netflix growing at a great pace - commercial content is pretty much worthless on phones, pads, and tablets. Give me a nice 40 inch screen and a full season of Wagon train, I'll gladly pay for it and so will the millions of our friends south of the geographic border.

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