Wall Street is turning on Netflix (Nasdaq: NFLX).
Analysts at Bank of America, Susquehanna Financial, and Kaufman Bros. are downgrading shares of the movie-rental specialist this morning.
It's a dangerous place to be -- for the analysts.
Betting against Netflix has been hazardous to the performance of Wall Street's pros.
A history of analytical failure
Back in mid-January, Lazard Capital Markets' Barton Crockett downgraded the stock, fearing that the service's year-end subscribers had clocked in at the low end of the company's guidance of 12 million to 12.3 million accounts.
He was wrong. Two weeks later, Netflix blew past analyst's fourth-quarter guesstimates, closing out the year at the highest end of its range with 12.3 million subscribers. It's dangerous to bet against the flick flinger so close to an earnings report since Netflix has bested Wall Street targets in each of the past seven quarters.
January's blowout quarter won it several analyst upgrades after the fact, including a move from "neutral" to "buy" from Merriman Curhan Ford.
I'm singling out that call, because Merriman Curhan Ford had downgraded the stock -- from "buy" to "neutral" -- nearly two months earlier. What did Netflix shares do between Dec. 1, 2009, and Jan. 28, 2010, as the analyst had turned on the company? Well, the stock rose 8% -- during a nearly two-month span that found the S&P 500 inching slightly lower.
Be kind and rewind
Netflix hit an all-time high yesterday, meaning that every analyst with a previously bearish or lukewarm opinion on the stock has missed. It happens. No analyst is perfect. The jury is naturally out on how this morning's downgrades will pan out over time.
The real doozy comes from Bank of America's Nat Schneider, taking the stock down from "buy" to "underperform" without a pit stop at "neutral" along the way.
Schneider feels that Time Warner's (NYSE: TWX) HBO Go is a significant new threat to Netflix's dominance on the streaming front. He's wrong about that. He also believes that the service's subscriber base would have to triple in five years to justify the current price. He's wrong about that, too.
Let's tackle HBO Go first. When Time Warner helped launch the TV Everywhere initiative, the plan was to make cable subscriptions more attractive by allowing customers to stream as much of the content that they are already paying for as possible.
HBO Go is impressive, offering up hundreds of HBO shows, specials, documentaries, and even some movies for online streaming. It's hard to knock HBO's content, but it's only available for couch potatoes who are paying for HBO on top of their costly cable or satellite television subscriptions. You can't compare someone paying $80-$100 a month for premium cable to the $8.99 Netflix subscription that offers unlimited digital delivery (as well as fresher releases on DVD).
HBO Go will be an important retention tool, but it's not going to get in the way of Netflix's compelling value proposition.
It's a long way out to 2015
Schneider's valuation argument is incomplete.
It's true that Netflix isn't exactly cheap these days. It closed yesterday at 28 times this year's projected profits and 22 times next year's estimate. It's comforting to know that analysts have done nothing but underestimate the company's actual earnings power over the past two years (so those multiples are probably inflated), but bearishness itself isn't a problem.
Assuming that Netflix's subscriber base will have to triple by 2015 to justify today's price, on the other hand, is a little nutty.
Let's go back five years, before shooting ahead to 2015. Digital streaming wasn't in the company's playbook. Netflix was simply building out its physical distribution centers, with Blockbuster (NYSE: BBI) and Wal-Mart (NYSE: WMT) as its only real competitors.
It's an entirely different marketplace today. It marginally competes for real-world DVD rentals from Blockbuster and Coinstar's (Nasdaq: CSTR) Redbox kiosks, while it stands alone in digital delivery. Apple (Nasdaq: AAPL), Amazon.com (Nasdaq: AMZN), and even Blockbuster are selling digital downloads and rentals, but none of them offer the unlimited spread that Netflix includes at no additional cost to its DVD plan subscribers.
If the Netflix model and competitive landscape have changed so dramatically from 2005 to 2010, why won't it be altered materially come 2015? International expansion is on the horizon. It's just a matter of time before Netflix follows Blockbuster and GameFly into video game rentals. As a cash-rich company, Netflix may very well acquire incremental revenue streams along the way.
In short, there are plenty of potentially positive catalysts to keep Netflix relevant, growing, and perpetually humbling the prognosticators. That final point is important. Betting against Netflix in the past hasn't paid off for bearish analysts. This morning's skepticism is likely facing a similar fate.
Is Netflix overvalued or undervalued? Share your thoughts in the comment box further down this page.
