On Tuesday, Netflix (NASDAQ:NFLX) got a big upgrade courtesy of Goldman Sachs. The Goldman analyst team increased its price target by more than 50%, from $380 to $590, and raised its rating on Netflix from hold to buy. However, the analysis behind this upgrade doesn't square with Netflix's track record.


Goldman Sachs' international subscriber growth assumptions are thoroughly unrealistic.

The recent trend toward Netflix bulls "piling on," even after the stock has rebounded by around 50% from its early May lows, is ominous. That's particularly true given that there hasn't been any real news about Netflix during that time. Bulls may be inflating another Netflix bubble that could lead to a lot of pain when it pops.

Goldman's bold call
While the Goldman Sachs analyst team likes Netflix's positioning in the U.S., their bullishness stems primarily from an assessment of its international growth trajectory. They believe that Netflix will grow rapidly outside the U.S. through a combination of adding new markets and increasing its penetration of each market.

Indeed, the analysts believe Netflix could have 61.7 million international subscribers by 2017, up from 10.9 million at the end of last year. This would drive the international contribution margin to more than 20%, from a loss today. In that scenario, Netflix would have a 29.7% penetration rate within a total addressable market of just over 200 million households by 2017.

This stands in sharp contrast to the expectations of other Netflix analysts -- even bulls. One recent bullish analyst estimated that Netflix might have just 53 million international subscribers in 2020. Another thought Netflix might reach 70 million international subscribers by then. Even that would be well below the trend being projected by Goldman Sachs.

Back to earth
While it's impossible to predict the future with any certainty, it is generally helpful to look to the past as a guide. With that in mind, Netflix's international growth in the last four years makes Goldman's projections look quite unrealistic.

At the end of Q1 -- when Netflix had been operating in its international markets for more than two years, on average -- it had 12.7 million international members. The addressable market in the countries launching this fall is smaller than in Netflix's existing international markets. Measured by broadband households, it is about two-thirds as large. Discounting the value of a Latin American household due to lower income and poor e-commerce infrastructure narrows the gap somewhat.


Netflix hasn't shown the ability to grow as quickly in international markets as Goldman Sachs expects.

There is no reason to expect Netflix to do better in its new markets than in its existing international markets. Based on the size of the addressable market, at the end of 2016 (more than two years from now), Netflix is likely to have fewer than 12.7 million subscribers in the markets being launched this fall.

Yet Goldman Sachs projects that Netflix will have 43.7 million international subscribers by the end of 2016 (and then gain another 18 million in 2017). These estimates would require much faster growth in Netflix's new markets -- or a dramatic acceleration in growth within its current international markets.

Into the clouds
To make matters worse, the Goldman Sachs analysts proceeded to conduct an analysis showing how profitable Netflix could be if it had the same economics as premium-cable titan HBO. This analysis "showed" that Netflix could be earning $57.83 per share by 2018 -- which could justify quite lofty price targets indeed.

There's just one problem. This analysis assumes that while investing heavily in new original programming, Netflix will spend approximately the same amount on licensed content in 2018 as it did in 2013.

Considering the general inflation in content costs and Netflix's entry into new markets, this implies a sharp cutback in the licensed content available on a per-country basis. For Goldman's model to work, Netflix would have to cut lots of content without slowing subscriber growth.

Foolish conclusion
It's clear that Netflix is on a strong growth trajectory. There is plenty of room for debate about just how strong that growth will be, and how long it will take Netflix to capitalize on its international growth opportunities.

Unfortunately, Goldman Sachs' recent note doesn't do much to further this debate. Without presenting much evidence, the firm assumes that Netflix will be much more successful in its new international markets than in its current ones.

If anything, Netflix will do somewhat worse in its newest markets than in previous international launches, as it is later to market and English fluency is lower there. Goldman's assumption that it will catch on much faster than ever before leads to highly unrealistic projections.

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Adam Levine-Weinberg is short shares of Netflix. The Motley Fool recommends Goldman Sachs and Netflix. The Motley Fool owns shares of 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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