In the month following its second-quarter financial report, streaming giant Netflix (NFLX 0.61%) saw its stock plummet as much as 21%, as the company posted a rare miss in its subscriber forecast. Netflix added 5.15 million subscribers worldwide, ending the quarter with 130 million customers, up 25% year over year, but falling far short of the 6.2 million it guided for.
At least one analyst thinks investors are overreacting to those results and underestimating the attraction of the Netflix model and its growing library of content.
Image source: Netflix.
The analyst
Guggenheim Partners analyst Michael Morris raised the company's price target to $420, more than 14% above the stock's current levels -- and among the highest among Wall Street analysts. In a note to clients, Morris made the case that subscriber gains could "significantly exceed" what investors are expecting. "Netflix subscriber penetration will significantly exceed what is implied in the company's current valuation," he wrote. "The Netflix offering is a substantial consumer value in price and utility, and an efficient model will continue to support a virtuous cycle of quality content creation, distribution, and monetization."
Morris goes even further, predicting that Netflix subscriber base will more than double by 2023, topping 285 million subscribers. He lays out a case that includes three underlying catalysts that will drive Netflix stock higher.
International expansion
Netflix's international expansion is booming and Morris believes it will continue. He is particularly enthusiastic about the potential for growth in India. "We see improving broadband infrastructure and a growing population of upper-middle class smartphone users as an attractive addressable market," he wrote. "Netflix is well-equipped to capitalize in this region." Morris thinks India will account for more than 5.5 million Netflix subscribers by 2021.
India is a high priority for Netflix, and CEO Reed Hastings has said, "Given the consumer base, the next 100 million [subscribers] for us is coming from India." Netflix has been investing heavily there, releasing numerous programs in recent months that could help drive penetration, that have received positive ratings on review aggregation site Rotten Tomatoes:
- Lust Stories (Critics: 100%. Audience score: 68%)
- Sacred Games: Season 1 (Critics: 90%. Audience score: 95%)
- Ghoul: Season 1 (Critics: 82%. Audience score: 82%)
Mumbai city cop Sartaj Singh in Netflix original series Sacred Games. Image source: Netflix.
Best-in-class technology
Having a decade-long head start on the majority of its competitors gives Netflix a technological edge. The company has had years to test and hone its streaming interface. As customers who have experimented with other services are likely aware, ease of use is one of the things that sets Netflix apart from the competition.
"We believe that consumers enjoy the increasing amount of high-quality content, but also believe that many people simply enjoy using the Netflix platform," Morris wrote. "We forecast that the company will invest $1.25 billion in technology and development in 2018, up 19% [year over year], with a focus on maintaining and further enhancing a seamless and enjoyable consumer streaming experience."
More than just streaming
As Netflix's library of original content grows, so does its stable of beloved characters. Morris believes Netflix will be making a big bet on consumer products, pointing to the company's poaching of Christie Fleischer from Disney (DIS +0.19%). Fleischer was the former head of merchandise and product development at the House of Mouse, and will lead Netflix's consumer products efforts. Her team will be charged with overseeing retail and licensee partnerships, publishing, interactive games, merchandising, and experiential events, according to a Netflix press release. Some believe this business could be worth more than $1 billion annually.
Morris sees this as a signal of Netflix's ambitions in the space. It is also an opportunity for "incremental, higher margin investments that should leverage Netflix's marketing efforts for children's series as well as mainstream originals."
We'll know soon enough
Netflix is expected to report the results of its third quarter on Oct. 16, after the market close. Last quarter's subscriber shortfall was a rare event for Netflix and occurring during the company's seasonally slower second quarter. Netflix experienced a similar miss two years ago, just to come roaring back in the months and years that followed.
I suspect it will be the same this time around.
