Netflix: A Strong Buy on the Pullback

In spite of the headwinds that Netflix faces from greedy Internet-service providers like Comcast, the company is in a very strong position to grow its revenues, subscribers, and earnings. Netflix's global expansion plans and compelling consumer services will make the company far more valuable in the years ahead.

Apr 1, 2014 at 5:30PM

The stock price of Netflix (NASDAQ:NFLX) has dropped from its high in the $450s to its current levels. There has been speculation about Apple (NASDAQ:AAPL) and Comcast (NASDAQ:CMCSA) trying to work together to structure an Internet-to-TV streaming deal. This sizable drop in stock price represents a great buying opportunity for long-term investors. 

Apple-Comcast deal will have no impact
When rumors surfaced about Comcast talking with Apple to deliver TV and on-demand video through the Apple TV set-box, the stock price of Netflix took a big hit. This piece of news, even if it is true, is highly immaterial for Netflix and its shareholders.

Comcast will most likely appear as an app on the menu of Apple TV, just like those of Hulu and Netflix. Comcast will certainly only make this deal available to its subscribers, and it will give consumers more options but it provides almost no benefit to someone who does not have an Apple TV device. Cable companies like Comcast and Time Warner Cable have been increasing their prices regularly but they have done little to deliver extra value to consumers. Not surprisingly, they rank among the lowest providers in terms of consumer satisfaction.

Toll collection a potential headwind in near-term
Netflix has started to see some headwinds from the weak net-neutrality laws, as it has disclosed that it paid Comcast to make sure that Netflix customers get higher-quality video. The company's CEO Reed Hastings wrote on the company's website that he believes ISPs like Comcast will start demanding tolls from other smaller service providers even though consumers pay them monthly subscription fees for high-speed Internet. This arbitrary tax will increase costs for consumers.

In other words, Netflix stated that the ISPs charge customers for high-speed Internet while also pressing Netflix and other high-traffic sites to pay them 'a toll'. This phenomenon will not likely continue for too long, as strong net-neutrality laws should help all parties involved: ISPs, service providers like Netflix, Hulu, YouTube etc., and consumers. However, in the wake of cable-industry consolidation this might become a headwind for Netflix and drive up its operating expenses in the near-term.

Compelling unique value proposition
In spite of the rumors and the placement of Internet tolls on the company, Netflix delivers an incredible value proposition to consumers at its price point of $7.99/month. The company has amassed more than 44 million subscribers, and based on its management's guidance it should end the first quarter of 2014 with more than 48 million subscribers in more than 40 countries. 

The company's brand value is on the rise and it has disclosed plans to expand into Europe, which will enable Netflix to build a global Internet TV franchise. In addition, the company's increasingly large content base includes highly valuable Netflix originals that include House of Cards and Orange is the New Black. Netflix has been constantly adding more and more original content with the large amount of subscription revenue it earns.

Netflix recently stated that it will bring back the political drama House of Cards for a third season. The addition of more high-quality original shows will result in additional subscriber gains. The company's revenue and earnings per share should get sizable boosts from this growth in subscribers. 

Going forward
Netflix does trade at rich valuations, but the company's subscriber and revenue growth have been phenomenal. Netflix delivers very attractive benefits to consumers. The agreement with Comcast will result in higher operating expenses, but it will ensure better-than-ever streaming quality and customer service.

Netflix trades at a forward P/E of 47.7, and owing to the subscription business model of the company, the company's earnings can ramp up quickly after the big investments in Europe have concluded. In 2014, Netflix is expected to grow its Diluted EPS by almost 130% year-over-year from 2013, so the high valuation multiple is justified.

The company is diversifying its revenue base across the globe and adding more and more original content. The company's current pricing model gives the company immense pricing power as well. Years down the road, Netflix will be a far more valuable franchise. 

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Ishfaque Faruk owns shares of Netflix. The Motley Fool recommends Apple and Netflix. The Motley Fool owns shares of Apple and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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