The following article is part of The Motley Fool's "Stock Madness 2005," a contest based loosely on the annual NCAA College Basketball Tournament, a.k.a. March Madness. From March 17 to April 8, our writers and analysts will engage in head-to-head competition with each other, advocating and arguing on behalf of 64 stocks we've selected as among the most interesting to Foolish investors. You, dear readers, are the fans and referees -- you'll read these exciting duels and then vote for the stock you think is the better investment... and should therefore move on to the next round of play. The company that survives six "games" will be our tournament champion, and its writer our most valuable "coach."
But, please, make no mistake -- "Stock Madness 2005" is a GAME!
Our writers are doing this for fun. They are enjoying the spirit of competition and the art of debate. They are delighting in the search for positives in the companies they've drawn... and negatives in the companies they're pitted against. They are NOT necessarily recommending these stocks as the ones they believe in above all others. As ever, YOU must decide whether the stocks we're writing about -- winners and losers -- are deserving of your investment dollars.
UPS (NYSE:UPS)
Atlanta
, Ga.
$73.16
52-week low-high: $68.55-$89.11
$81.8 billion market cap
By Nathan Slaughter
And then there were four: Apple (NASDAQ:AAPL), Sirius (NASDAQ:SIRI), Netflix, and UPS. Right away, this looks like a classic mismatch on paper. UPS is the only "old-economy" company to have survived among this group of tech darlings, each of which boasts a highly partisan base of loyal (read: fanatical) followers. Thus, it enters today's contest with the one handicap that seems to have sent so many others packing in this tournament -- a ticker symbol with fewer than four letters.
Nevertheless, I think this fundamentally sound company has what it takes to advance to the finals.
At this stage, there's little sense in reiterating exactly what these two companies do, except to say that both are into delivering packages. But whereas shipping a few extra packages to a given address translates to increased profits for UPS, it just represents increased liabilities for Netflix. Round-trip postage isn't getting any cheaper these days, and the extra savings squeezed out of those few customers like me -- the ones who have but a single movie in their queue and may or may not watch it within the next two weeks -- is subsidizing others who are busy renting 10 or more movies month in and month out.
Then again, I'm a satisfied member of the Blockbuster (NYSE:BBI) online rental community anyway, and in another year, there will be more than 2 million of us. Does Netflix offer a larger library? More efficient delivery? A better ratings system? Possibly. But the monthly value that I'd place on all of those bells and whistles combined doesn't begin to offset the higher price that Netflix charges. Blockbuster has 99.99% of all the movies I would ever care to watch available, and I'm sorry, but the random opinions of former viewers mean absolutely nothing to me.
I know that those incentives are important to some people. That's why Netflix's subscriber base continues to grow even though the company's prices have been undercut. Still, Blockbuster's foray into the business has prevented Netflix from raising prices; in fact, it has brought about price cuts and essentially capped the income that can be generated from existing customers. And recent stepped-up promotional efforts are doing nothing to reduce the costs associated with acquiring new subscribers.
Naturally, as a much smaller company, Netflix is bound to show faster growth rates.
However, nobody knows exactly where this nascent industry is headed. There's a huge disparity among analysts, with fiscal 2005 forecasts ranging anywhere from losses of $0.09 per share to a gain of $0.25. Even the most optimistic outlook, though, is still predicting a steep decline from the $0.57 earned last year. Meanwhile, UPS is looking at reliable earnings growth in the mid-teens over the next few years.
I like Netflix, but I'd rather put the ball in the hands of a proven scorer than roll the dice on a promising, but still unpredictable, rookie.
Fool contributor Nathan Slaughter owns none of the companies mentioned.
Netflix (NASDAQ:NFLX)
Los Gatos
, Calif.
$10.97
52-week low-high: $8.91-$38.62
$580 million market cap
By Rick Aristotle Munarriz (TMF Edible)
Netflix and UPS in the Final Four? Sweet. Whether you go with brown trucks or red envelopes, it's cool that one of the companies going to the championship game later this week will have gotten there by conveniently providing goods to your front door.
I like UPS. The nature of this contest, where popularity rules, indicates that a lot of you feel the same way. But let's take a closer look at the investing potential of these two stocks, because that's what you should really be basing your vote on -- the stocks, not the companies. Revenues? UPS grew its top line by 9% last year, and analysts expect the company to grow its revenue by another 9% this year. That's consistent. Improving margins may help prop earnings growth into the teens, but that's really as good as it gets with UPS.
Netflix, in contrast, grew its revenue by 86% last year. As it grows from 2.6 million subscribers to 4 million in 2005, revenues will climb by at least 40%. You'd expect to pay up for the faster grower, but that's not the case here. You can buy Netflix these days at an enterprise value-to-2005 sales ratio of just 0.6. UPS's EV-to-sales figure is 2.0 -- more than three times higher.
Sure, Netflix will put up a small loss for the March quarter as it begins its seasonal aggressive marketing, but it is looking to post a profit for the last nine months of the year, and Wall Street has the company trading at a lower earnings multiple than UPS will come 2006.
UPS is great. I get it. It ships to more than 200 countries and sends out more than 18 million packages a day. That's awesome. But investors buy into companies for their growth potential because the past is already baked into the current price. Netflix has more of the market to penetrate. Netflix has 199 more countries to enter before it catches up with UPS. It has yet to tap the video game rental market. It's developing a video-on-demand service. You know what Brown can do for you, and you know what you'll get -- and it's steady -- but the catalysts for greatness and true capital appreciation define the potential in Netflix.
Even if you came in ready to cheer on UPS until your throat was hoarse, you probably wouldn't mind walking away wearing a Netflix jersey.
Fool contributor Rick Munarriz has been a Netflix investor -- and subscriber -- since 2002. He does not own shares in any of the other companies mentioned in this tournament match.
Rebuttals
Rick mentions that Netflix seems cheap as measured by sales, but so do many companies with similarly thin margins where those sales barely trickle to the bottom line. On a level PEG playground, UPS looks far more reasonable, trading at 1.5 vs. a rather exorbitant 4.3 at Netflix. And that's after Netflix's shares have been clobbered, losing around 70% over the past year.
It's easy to say that small companies have the edge because they have more room to grow, but not too many acorns survive the harsh winters and raging forest fires to grow into a towering $80 billion global powerhouse like UPS. Again, I'll take the proven leader, particularly when it has higher (and steadily increasing) dividends, higher operating margins, and a more stable earnings picture. -- N.S.
Is UPS 200 times the company that Netflix is? That's what each company's enterprise value seems to suggest. I disagree. Even if you think that Netflix should be valued at just 1% of UPS, you are still talking an easy double from here. Is Netflix's buffet model flawed? If so, the plan it is currently promoting -- and the only one that Amazon (NASDAQ:AMZN) is offering overseas -- is capped. If that card needs to be played, Netflix has it up its sleeve.
Oh, and "random opinions" undersells Netflix's proprietary software. The recommendations and reviews aren't random at all. They are based on those with similar viewing and rating patterns. Brown? Red? If you were a bull, what color would you choose? -- R.M.
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