Movie provider Netflix
So what should investors do? Here's a quick look at some arguments for the three possibilities.
Buy
- Distribution of content: Netflix's library of DVDs is quite large and choices are delivered straight to customers' homes. This convenience has essentially put Blockbuster out of business. The streaming library is growing and is available on more and more consumer devices with no additional work on the part of customers. And the price is a great deal for customers, giving unlimited ad-free content -- both streaming and on DVD -- for a price lower than Hulu's streaming-only, ad-containing offering.
- Growth: Throughout the recession, Netflix grew its subscriber base. As the economy comes out of that trough, growth should accelerate. Add in the launch of an international presence sometime in the second half of the year, and it will take many years before Netflix reaches saturation. Plus, despite all the commentary calling for the end of DVD use, Netflix expects this portion of its business to continue to grow for at least a couple more years, with a relatively long trailing off as more people become able to and are willing to switch to streaming as their primary means of watching movies or TV shows.
Sell
- Price: At a share price of $121.11, Netflix trades at 54.8 times trailing earnings and more than 34 times estimates for 2011's earnings. Pretty expensive. And its enterprise value-to-free cash multiple is also pretty hefty at 53.5, counting the acquisition of a library as a capital expense. That's a lot of growth priced in. Unless it can show significant international growth -- something that investors can still only guess at -- there isn't enough growth remaining in the U.S. to justify that high a price.
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Competition: Hulu has deep-pocket owners who are strongly motivated to monetize their content libraries. They can help Hulu undercut Netflix on acquisition prices, which allows Hulu to begin a price war that could damage Netflix just like Netflix was able to hurt Blockbuster. Cable operators and movie studios are also motivated to seek as many outlets as possible for their content, avoiding total reliance on Netflix. To a large extent, Netflix is a price-taker when striking content deals with providers like Time Warner
(NYSE: TWX) , even when Netflix gets great content like Nip/Tuck and Pushing Daisies from Time Warner's Warner Bros. Home Entertainment Group.
Hold
- Growth: Netflix is supposed to launch into a single foreign country this year. Adoption and growth could be quite significant, in which case today's price could look cheap as the company expands elsewhere. But the uncertainty of success is high enough that purchasing shares at today's price is an iffy proposition.
- Competition: The battle for streaming is just heating up, and Hulu, with its millions of viewers, has a large base to work off of with an expectation of good deals for content. Having said that, it could be difficult to convert viewers from a free, ad-based experience to a subscription model. Until there's more information, current shareholders should hold on.
The final call
Despite it being an active recommendation of both Gardner brothers in Stock Advisor, I'm going to exercise my Foolish prerogative and go with the hold position here. Netflix's share price has run up a lot in the past year, and with the very uncertain subscriber growth possibilities, valuation models give a very wide range, as the Wall Street analysts have shown.
Netflix has beaten earnings for the past eight quarters, but at some point, it's going to miss, just like many other growth stocks have done, if for no other reason than analysts expect too much. When that happens, the stock price will be punished. Yet the company could beat once again and the price could rise from here, especially if the international service is a hit. Given the opportunity versus the uncertainty, I'm comfortable holding my shares, but am not looking to add at this point.
