This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts, and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." While the pinstripe-and-wingtip crowd is entitled to its opinions, down here on Main Street, we've got some pretty sharp stock pickers, too. (And we're not always impressed with how Wall Street does its job.)

Given that, perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

Today, we're looking at a couple of conflicting analyst actions on fallen market darling Netflix (Nasdaq: NFLX  ) .

Running with the bears
On Monday, Morningstar analyst Michael Corty cut his price target on Netflix from $80 to $55. Morningstar maintains a two-star rating on the stock, which translates into a mild "sell" rating.

Corty sees international expansion as a "drag" on the stock, and calls the streaming business model "flawed" because content producers "are getting the much better end of licensing deals with Netflix." In short, Corty thinks that Netflix should abandon overseas growth and reinvest that capital into defending its dominant domestic market share. And serious media investors, Corty notes, would be better served by creative powerhouse Time Warner (NYSE: TWX  ) domestically or Grupo Televisa (NYSE: TV  ) in Latin America. These are wide-moat businesses with "great content and distribution assets," unlike Netflix which is at the mercy of these giants.

Then there's Sanford Bernstein analyst Todd Juenger, who conducted a focus group with 16 American moms and walked away with one conclusion: Netflix is a threat to Walt Disney (NYSE: DIS  ) and Viacom (Nasdaq: VIAB  ) , and the media giants should do everything in their power to kill Netflix as soon as possible.

In fact, he expects the studios to follow his unsolicited advice: "They will either limit the availability of kids' content to Netflix or try to compensate for the negative impact on ratings by increasing the price of streaming licenses." Either way, Netflix would lose by missing out on valuable content or getting hit with bills it just can't pay.

Intermission
If these bearish analysts hogged the pulpit on Netflix this week, you'd expect shares to plunge through the floor -- but the stock jumped 7% on Tuesday and as much as 15% on Thursday. As you might expect, bullish analysts played a part in that action and they'll get the mic here in a second. But first, let me address a couple of bearish notions that won't come up in the second half of the analyst roundup.

Mr. Corty actually rebuts the Bernstein argument, quite by accident. "We believe Netflix's business model is flawed as most of the economic rents flow through to the content owners," Corty said. That was meant as a scathing critique of weak profitability, but highlights how Netflix helps drive value to the studios in the digital age.

Elsewhere, Viacom CEO Philippe Dauman says that Netflix isn't hurting Nickelodeon's ratings at all: "We don't think that the availability of the limited amount of Nick library content on Netflix ... has had a significant impact," he said in a recent earnings call.

As for Corty's own core concern, let me point out that America is a big but limited market. Protecting market share here ignores some 95% of the global population, and that's a huge mistake. International expansion is a mistake if and only if Netflix fails to become profitable in the new territories. I don't think that's a terrible risk to take, given the low cost of digital operations and the increasingly obvious value that Netflix provides for media producers. And at that point, Corty actually rebuts himself with his economic flow argument.

Welcome to Pamplona
On the bullish side of the street, we find Citigroup's Mark Mahaney, who reiterated his $130 price target and buy rating because Netflix is ridiculously cheap today. Do the valuation math on Netflix's domestic business alone, Mahaney says, and you arrive at shares selling for just 12 times domestic earnings with a "free call option" on international growth.

Mahaney also notes that customer satisfaction and tablet users are on the rise, though the Netflix website gets 7% fewer hits than it did a year ago. (I'd argue that more mobile apps and Netflix-enabled set-top boxes reduce the need to visit Netflix.com, which would explain much of that drop.) All in all, that's a very bullish note, and the main catalyst for this week's big price jump.

Finally, BTIG Research's Richard Greenfield caught wind of the news that Netflix streamed 1 billion hours of content in June and sat down to figure out how that eyeball magnetism compares to traditional TV networks.

The conclusion? If Netflix were a cable channel, it's be the second-most-watched station available, just behind the Disney Channel and ahead of ESPN (both parts of the Disney empire). And adjusting for distribution, Netflix becomes the most-watched network of any kind in households that have a subscription.

The average member household watches some 80 minutes of Netflix content per day, which is a very substantial share of the five hours per day that Americans spend on daily entertainment.

The bears do raise some valid points. Content is expensive, and the studios do hold a strong hand in license negotiations. International expansion isn't a gimme, and will hurt earnings until the new territories gain serious traction. But I believe Netflix has the answers to these challenges, and that the stock should rebound strongly as the story plays out.

The CAPS community isn't all that impressed. Today, Netflix holds a solidly "meh" 82% approval rating and a below-average two-star rating out of five. If you agree with my analysis, you can raise Netflix's score by clicking over to CAPS and adding your own thumbs-up rating.

If  two stars don't get you excited, be sure to learn about a five-star-rated stock that is also an active pick of our Rule Breakers newsletter service. Claim your copy of this special free report entitled "Discover the Next Rule-Breaking Multibagger" before it's gone!

Fool contributor Anders Bylund owns shares of Netflix and has also set up a bull call spread on Netflix that breaks even at roughly $100, but holds no other position in any of the companies mentioned. The Motley Fool owns shares of Netflix and Walt Disney. Motley Fool newsletter services have recommended buying shares of Netflix and Walt Disney. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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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 09, 2012, at 1:56 AM, MrSinnister wrote:

    When will Discovery Labs (DSCO) finally get some love? I mean they have 2 FDA approved products that go into distribution in the 4Q, with the FDA approval coming in March. They only have 43 million outstanding shares, with a current market cap of 125M which nearly multiplies with every 10 cent increase. They are going to distribute a drug for Respiratory Distress Syndrome for infants in the US and European markets, and they have TREMENDOUS upside, already up 60 percent on the year. Add to that two more drugs awaiting approval, Aeroserf, that is in a collaboration with Batelle to get streamlined and fine-tuned and Surfaxin LS, a liquid version of their already FDA-approved drug Surfaxin. How this stock stays in the 2 range is amazingly shortsighted.

    Value of Surf LS + Afectair: 275million

    Shares O/S: 43mil

    Tell me why we can't see $40+/share with DSCO. Note that my sell target is below this, but I expect the stock to soar once it gains momentum. Imagine that liquid surfaxin penetrates the market quickly and gets great reviews by practicing docs (which it should). Surf LS will be even better. And Aerosurf even better after that.

    Facts:

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    8. exclusive rights

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    At 3 times sales, this is already $400 million firm, and that is $10 PPS. DSCO === Hidden Gem.

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