I have to admit Netflix (Nasdaq: NFLX) is a beast of a stock. Just two weeks ago after posting pretty poor quarterly results, I wrote about the bear case for the stock. The stock was trading at about $120 when the company reported earnings, and in just a week's time it traded down to $95.33 on the poor results. However, in less than two trading weeks the stock has made up its losses and then some, closing yesterday at a new 52-week high of $133.05.
Some of the move back up can be attributed to investors who may have missed David Gardner's recommendation of the stock more than 100 points ago, worried about missing another run. However, investors are also excited about the company's new content-sharing agreement with Epix, which will allow the company to stream content produced by Lions Gate (NYSE: LGF), Paramount, and MGM.
While the deal will certainly help draw some new subscribers, as Netflix now has access to a much greater library of content, the cost of the deal only furthers the bear case I spoke of.
In 2008, Netflix inked a very similar content-sharing deal with Starz. This deal gave Netflix the right to stream Disney (NYSE: DIS) and Sony (NYSE: SNE) titles. The problem for Netflix is the Starz deal only costs about $30 million a year, whereas the Epix deal is a $1 billion deal that averages $200 million for each of the next five years.
Netflix's price appreciation over the past few years has been a growth story, but more importantly, a margin story. Margins have grown from 5.6% in 2007, to 6.1% in 2008, and 6.9% in 2009. However, as the premium continues to increase just to gain access to the content customers crave, these margins will see continued pressure.
Stifel Nicolaus analysts believe that Netflix will have to attract 500,000 more customers per quarter than the company is currently estimating in order to maintain its current margin growth. This seems pretty unlikely, and even more costly if the previous quarter's subscription statistics are any indication. In the second quarter of this year, the company brought in 600,000 fewer subscribers than the previous quarter while spending the same amount on marketing to attract new customers.
Netflix is clearly impressing investors with its continued growth and innovation. However, a company that trades at a price-to-earnings ratio above 50 needs to always be at peak performance. Competition for content and customers still makes me believe this will be difficult to achieve.
