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Netflix, Inc. (NFLX): Investing in Streaming Stocks Could Be Risky

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Netflix, Inc. (NASDAQ:NFLX) offers some of the best investment opportunity among the major music and video streaming stocks. The company has solid fundamentals, attractive valuation based on a number of metrics, and a competitive position that should allow the company to continue to grow in this evolving area. While other companies, such as Sirius XM Radio Inc (NASDAQ:SIRI) and Pandora Media Inc (NYSE:P), are also fast growing, their business models must overcome much larger competitive threats in the next few years in order to thrive. Accordingly, their common stocks appear much riskier than Netflix.

Fundamentals and valuation

Netflix, Inc. (NASDAQ:NFLX) has 56.1 million shares outstanding, for a market capitalization of about $13.7 billion. In comparison, Sirius XM Radio Inc (NASDAQ:SIRI) has 6.4 billion shares outstanding and a market capitalization of $23.2 billion, and Pandora Media Inc (NYSE:P) has 174.8 million shares outstanding for a market capitalization of $3.2 billion. Below is a table with several fundamentals and valuation measures for each company.

A quick look at the numbers shows a different situation for each company. Price-to-book value is not very important when investing in growth companies, although Pandora Media Inc (NYSE:P) is clearly overvalued based on that simple measure. Further, Pandora does not have significant fixed assets, as it does not take a lot of fixed assets to re-transmit music over the internet.

Netflix, Inc.Netflix, Inc. (NASDAQ:NFLX) is the clear winner based on price-to-sales ratio, new subscribers, and international reach. International markets are important for content-creating companies, such as Netflix and Sirius XM Radio Inc (NASDAQ:SIRI), as they create their own content and, if they can sell it internationally, the return on investment is nearly 100% because the content is already there. A problem with international distribution is illegal viewing. For example, Netflix’s original series’ are reportedly pirated abroad within 24 hours after their release.

Pandora Media Inc (NYSE:P) has only recently started operations in New Zealand and Australia, and the large rise in paying subscribers was due, primarily, to the fact that it limited the number of hours its mobile users can listen for free to 40 hours per month. As a result, many hardcore listeners switched to Pandora One. Sirius XM Radio Inc (NASDAQ:SIRI) has operations only in Canada. It seems like Netflix, Inc. (NASDAQ:NFLX) is still growing healthily while having relatively inexpensive shares.

Netflix Sirius Pandora
Price-to-book value 16.8 6.2 38.5
Price-to-sales 3.6 6.6 6.7
Enterprise value $13.4 billion $25.1 billion $3.1 billion
Current ratio 1.5 0.7 1.5
% of stock owned by officers and directors 9.7% 0.4% 31.6%
Revenue growth (latest quarter this year vs. same period in 2012) 17.7% 11.9% 32.8%
Net new subscribers in last quarter 2,028K 452.9K 700K*
International revenues as % of sales 13.9% 1.2%** nil

Source: CapitalIQ, Thomson Reuters, SEC filings, author’s calculations.

* Includes only Pandora One paying subscribers

** Due to a 38% equity stake in Sirius XM Canada

Competitive advantages and disadvantages

Pandora Media Inc (NYSE:P) relies primarily on advertising for its revenue, and advertising can be volatile, as it decreases during recessions and in years when there are no political elections. At the same time, its music licensing and royalty fees are fixed, and currently represent over 65% of Pandora’s revenue. Traditional radio companies and satellite radios pay much lower licensing fees than Pandora does. For example, Sirius XM Radio Inc (NASDAQ:SIRI)’ royalties fees represent about 16% of the company’s revenue, and traditional radio companies pay an even lower portion of revenue for licensing. Pandora is actively lobbying Congress to change the law, and it also purchased a real radio station, KXMZ-FM, in Rapid City, South Dakota, in an effort to reduce its licensing fees. While Sirius has also launched a customizable radio station, My SXM, it is still able to acquire content at reduced rates. It is difficult to predict whether Pandora can successfully lower the amount it pays for music.

On the positive side, Pandora Media Inc (NYSE:P) is able to target its users with better ads because it has their demographic information, and is also able to give exact information to artists about their audience. As a result, Pandora is seeing an increased interest in local advertisement and is adding sales people on the ground in 28 major markets. Also, Pandora is benefiting from the switch to mobile, as 79% of the 4.2 billion hours of music its users listened to in the latest quarter were on mobile devices. Also, mobile ads generated two-thirds of the company’s revenue.

Netflix, Inc. (NASDAQ:NFLX), which recently surpassed HBO in the number of subscribers (29.2 million for Netflix versus 28.7 million for HBO), is able to negotiate directly with content providers. For example, earlier this year, it negotiated over 300 hours of exclusive content with Dreamworks Animation Skg Inc (NASDAQ:DWA). The first release of DreamWorks content, Turbo F.A.S.T., is expected for Dec. 2013. In addition, Netflix (and Sirius XM Radio Inc (NASDAQ:SIRI), to a lesser extent), creates its own content. The company’s popular show, House of Cards, cost $100 million to make and is expected to be the first “web only” show to be nominated for an Emmy.

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