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Netflix, Inc. (NFLX): A Risk Worth Taking

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Netflix, Inc. (NASDAQ:NFLX) has been in a downward spiral since its 2011 all-time high of almost $300 a share. A recent upswing, which has helped push the stock up 60% over the last three months, comes from activist investor Carl Icahn. Icahn announced a 10% stake in the video streaming company a few months ago, and investors have been expecting a range of bullish scenarios since. Most are now hoping for more efficient operations or a possible sale of the company to a synergistic buyer, such as Amazon or Microsoft. Billionaire Eddie Lampert also followed Icahn’s lead by adding Netflix to his portfolio during 3Q (check out Eddie Lampert’s latest picks).

ESL INVESTMENTS

The concerns for the company, besides increased competition, are continued losses in international markets. Pressured earnings continue to be a result of high expansion costs, which are mostly related to marketing and content acquisition. Now, new streaming content should be a long-term positive for Netflix, as it continues to push its churn rate down, while also attracting new subscribers. Netflix moved into Canada in 2010 and pushed its total footprint in Latin America to over forty countries, with recent expansion including Norway, Denmark, Finland and Sweden.

Netflix’s recent quarterly results showed that its subscriber base was up dramatically. As of 3Q, Netflix boasted 31.8 million unique subscribers, up from 25 million year over year. International subscriber addition also continued, up to 4.3 million from 1.5 million one year earlier – nearly threefold. The video streaming company was able to boost its paid-to-total subscriber base from 67% in 3Q 2011 to 86% last quarter in the international segment. We believe that international operations will continue to be a drain on earnings in the interim, but this will be the driving force behind Netflix’s 20%+ long-term EPS growth rate, which is expected by the majority of sell-side analysts.

The valuation on Netflix may also cause concern for some investors, trading with  a forward P/E of 220x. Netflix trades at only 1.5x sales, though, compared to other high-growth tech stock Amazon (2.0x). The video streaming company also enjoys impressive margins, with a 70% gross margin, compared to Amazon’s 25%, and satellite companies like Dish Network and DirecTV, which are both near 40%. Assuming investors can overlook the interim uncertainty of Netflix’s cost structure due to its efforts overseas, Netflix should be afforded the luxury of trading in line with Amazon on a top line basis. Based on this fiscal year’s sales estimates, shares of NFLX should easily trade at $130 per share, far above its current stock price of $95.

Coinstar, Inc. (NASDAQ:CSTR) competes with Netflix through its RedBox segment. The retail service provider does trade on the cheap side at 10x forward earnings, and has solid growth potential with its possible expansion into online streaming. If executed effectively, this will be a key driver in helping Coinstar meet its expected 5-year earnings growth rate of 17%. We do remain skeptical that Coinstar will be able to fend off rising stars – Hulu and Verizon’s streaming service – as easily as Netflix, though. Other investors appear to share similar sentiment, as Coinstar has a whopping 38% short interest. Although Coinstar does have its issues it still attracts billionaire investors, including Ken Griffin and Jim Simons (see Jim Simons’ top picks).

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