As ridiculously overpriced as bears would have you believe Netflix (Nasdaq: NFLX) to be, the converts keep coming.
The latest believer is Mark Mahaney. The Citi analyst is upgrading his rating on the video rental giant -- from hold to buy -- and raising his price target from $245 to $300.
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"We took a fresh valuation cut at this," Mahaney explained on CNBC's Fast Money last night. In a move that Mahaney admits proved fruitful in upgrading restaurant reservations specialist OpenTable (Nasdaq: OPEN) last fall, Citi chose to break out Netflix's steadily growing stateside business and the upside sizzle of international expansion.
The sum of Netflix's parts
Mahaney sees Netflix earning between $7 and $8 a share from its domestic operations next year. He pegs a stock value of $260 to $270 on that business alone.
International expansion, which is likely to run at an overall loss for the next few years, will be bonus gravy.
Even though Netflix's Canadian operations should be profitable later this year, the company is ready to stamp its passport by expanding into a new territory during the second half of this year and a third international market come early next year.
Mahaney's right. Why should investors penalize a company for losing money in the near term during overseas expansion? The market was wrong when it penalized Travelzoo (Nasdaq: TZOO) for losses that ate into the travel deals publisher's stateside profits. The market was wrong when it handicapped OpenTable for the soft engagement in Europe relative to its domestic foodies.
Travelzoo and OpenTable have trounced the market over the past year. Netflix has, too, obviously.
The long and winding road to $300
Mahaney's affection can be fickle. He has downgraded, upgraded, downgraded, and now upgraded Netflix's stock over the past year.
"I've missed a good chunk of this recent move in the stock," Mahaney confesses. "We'll see if we can get this next move right."
The $300 price target is aggressive. Expecting Netflix's stateside business to earn as much as $8 a share next year is equally aggressive. Analysts see net income of only $6.49 a share next year, but that also includes the initial losses of international expansion.
Canada's streaming product has been a success, but it has come at a price. Canada dealt Netflix an $11 million operating loss this past quarter, a tab that's now at a $22 million deficit since last year's third-quarter launch.
It will be worth it.
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Netflix is widely believed to be targeting Britain and Brazil as its next two markets. The United Kingdom makes sense, even if it means that it will butt heads with Amazon.com's (Nasdaq: AMZN) Lovefilm.
Brazil makes even more sense. Latin America is ripe for Netflix. DIRECTV (NYSE: DTV) has 5.8 million subscribers in Latin America. That's a lot of couch potatoes, especially when you consider that Netflix is in more stateside households than DIRECTV. The near-term pain will result in long-term gain.
What does it mean if Netflix manages to earn $8 a share from its core U.S. business next year? For starters, it would mean that the stock closed last night at an earnings multiple just shy of 30. This may not sound cheap, but fast-growing market leaders in redefining industries are worthy of healthy premiums.
Yes, Netflix is creating an entirely new category with its premium streaming. Bears that point to escalating streaming costs forget that Netflix will have to buy and ship out fewer DVDs in its digital future.
Fulfillment matters. Mahaney points out that it may cost $0.90 to mail a disc back and forth, but it's just a $0.05 hit in streaming costs. Instead of the Postal Service gobbling up gobs of Netflix revenue, why not let a low-balling content delivery network serve the flick with Netflix and the studios taking a bigger bite of the balance?
A lot of things can go wrong along the way. Competition can get smarter. Tiered broadband pricing can eat into the digital smorgasbord's allure. The slow fade of optical discs as a differentiator will level the playing field.
However, betting against Netflix has been a losing proposition because unexpected positive catalysts -- if you can call overseas streaming and the death of traditional DVD rental chains unexpected -- have outnumbered the negative.
Deny Netflix a happy Hollywood ending at your own peril.
Do you think Netflix will hit $200 or $300 first? Share your thoughts in the comment box below.
