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Netflix, Inc. (NFLX) – Is There More Upside?

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A lot has been said of Netflix, Inc. (NASDAQ:NFLX). It was one of the hottest stocks from 2008 to July 2011, and one of the worst stocks from July 2011 to 2012. It is extremely rare to see a
turnaround in tech, but Netflix, Inc. (NASDAQ:NFLX) stock has done just that. Should investors buy for more upside or avoid it all together?

The moat

Netflix, Inc. (NASDAQ:NFLX) has a great product. It is extremely easy to watch any of the 75,000 movies and TV titles for a low price of $7.99 on demand. The killer app quality was the reason why Netflix, Inc. (NASDAQ:NFLX) stock rallied from $20 in 2008 to $300 in July 2011. But concerns of competition from Amazon.com, Inc. (NASDAQ:AMZN) and Google Inc (NASDAQ:GOOG) as well as mishandling streaming video price increases hit the stock and sent it back down to  below $60 per share.

Investors were concerned that Netflix, Inc. (NASDAQ:NFLX) lacked a moat. The logic was that since Amazon.com, Inc. (NASDAQ:AMZN) and Google Inc (NASDAQ:GOOG) already had the user base and tens of billions of dollars on the balance sheet, they could replicate Netflix, Inc. (NASDAQ:NFLX)’s services, raise Netflix’s content costs, and basically bankrupt the company.

Netflix has responded to those criticisms by acquiring original programming and keeping them as Netflix exclusives. The thought was that since Netflix had shows that no other provider had, its subscriber base would stay. As part of its plan, the streaming video provider developed the shows House of Cards, Hemlock Grove, Orange is the New Black, and Lilyhammer. It also carried the fourth season of Arrested Development.

Netflix has said that all of its shows have engaged large audiences, but they have not released any specific numbers. It
did say that Arrested Development brought “a small but noticeable bump in membership.”
The overall cost of the original programming accounts for 5% of the $3 billion in total amortized content costs.

The fundamentals

Currently, Netflix shares trade more on future potential rather than current value. Netflix has a price to earnings ratio of 580, forward price to earnings ratio of 80, and a next 5 year EPS growth rate of 19.50%.

Netflix second quarter earnings missed analyst expectations with lower than expected subscriber numbers. Analysts were expecting around 700,000 net domestic subscriber additions, while Netflix added around 630,000. Netflix did beat analyst expectations on earnings with $0.49 per share on revenue of $1.07 billion versus analyst expectations of $0.40 per share on revenue of $1.07 billion.

At the end of the second quarter, Netflix has about 29.8 million US subscribers and another 8 million internationally. With a market capitalization of $14.5 billion, that works out to be $381 per subscriber, which is roughly in line with the $385 per subscriber valuation Netflix had in the first quarter.

Looking ahead, Netflix is forecasting third quarter net subscriber additions to be higher on an annual basis and for consolidated earnings to fall between $0.30 and $0.56 per share.

The activist

In late 2012, corporate activist Carl Icahn bought 5.5 million shares or 10% of Netflix for an average price of $58 per share. The famous corporate raider originally bought the stock with the intention of forcing Netflix to sell itself, but since the shares rebounded, Icahn has not agitated for any change.

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