At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.
But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.
And speaking of the best ...
What do you do when one of the best investors in the business abruptly loses faith in one of its biggest winners, and tells you to stop buying the stock? Me, I listen up. And from what I hear, All-Star analyst Morgan Keegan thinks it's time to pull the plug on Netflix
Reacting to last week's news that Netflix is paying Epix $1 billion for the rights to stream movies from Viacom, MGM, and Lions Gate over its streaming video service, Morgan Keegan crunched the numbers and came to the following conclusion: Netflix is paying $1.11 per month per subscriber for the rights to stream Epix video. This $1.11 is for a service where, depending on how you look at it, Netflix either: (a) collects $8.99 per month for, when customers use Netflix primarily for its streaming offerings, or (b) gives away for free (since these customers can also receive DVDs by mail).
Giving away the store
Admittedly, this isn't the worst news we've ever heard. As Google
Translation: Now that the cat's out of the bag on how much Netflix is willing to pay for streamable content, the purveyors of such content are free to ask it for just a little bit more (and more, and more, and ...).
How much more?
Honestly, that depends on how good each side's negotiators are. If the periodic face-offs between providers like Disney and Viacom, and distributors like Comcast and DISH Networks are any guide, negotiations over content pricing can get pretty rough and tumble. But even if they don't, even if both sides play nice, the price Netflix is already paying looks plenty steep.
Consider that $1.11 per user per month is enough to instantaneously shave more than 11 percentage points off of Netflix's already skimpy 38% gross margin. If that margin drop should happen to fall directly to the operating profit line, it'd be sufficient to wipe out nearly all of Netflix's operating profit margin in one fell swoop (based on the past four quarters).
All of the above would be bad enough, but to see the true danger here, let's consider one more point. Assume everything works out just dandy for Netflix. Assume that by expanding its library with Epix content, it's able to outdistance the competition and advertise itself as having the world's biggest library of instantly available, on-demand movies. As a result, the company keeps on growing at analysts' projected 27% annual clip.
In this world of wine and roses (or popcorn and soda pop), Netflix still looks too expensive at more than 50 times earnings. Even worse, if Keegan is right and the stock falls to $100 within a year, Netflix would be selling for an almost-as-pricey 40 times multiple (or 33 times Morgan Keegan's best guess at this year's earnings).
To me, these already look like excellent reasons to sell Netflix today. Toss in the potential for profit margins vaporizing as the Epix costs begin showing up on Netflix's income statement, and ... well I'll let my actions speak for themselves. Right now, I'm heading over to Motley Fool CAPS to put my reputation on the line, and rate Netflix an underperformer.
Think I'm wrong? Visit CAPS for yourself, and bet against me. May the best Fool win.
So far, so good. Fool contributor Rich Smith has a pretty good reputation on CAPS, ranking as the 537th best investor out of the more than 165,000 CAPS members we track. Out of the many, many stocks mentioned above, he owns only Google, and is short none of the above. The Motley Fool has a disclosure policy.