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.
With Netflix shares trading around $240 per share, Icahn’s 10% stake is now worth $1.3 billion giving him a $1 billion profit. In order for Icahn to cash in on his windfall, he must sell some of his shares, thus putting an overhang on Netflix stock in the short term. Icahn himself has not said when he will cash out, but with Netflix shares trending higher, the chances of Icahn leaving increases every day.
The competitors
Both Google and Amazon compete against Netflix in the internet streaming video market.
Google competes against Netflix with YouTube, the third most frequently visited website in the world with more than 1 billion unique users per month. YouTube has shown that it is adept at broadcasting live events such as the presidential debates or the Red Bull Stratos space diving event.
Right now, YouTube monetizes its user generated content plus music videos solely based on ads, but it could easily move into the Netflix area and compete. Google has over $40 billion in cash on the balance sheet and is currently haggling over content deals with Hollywood studios. Morgan Stanley predicts that YouTube will generate $20 billion in revenue and $5 billion in profit a year by 2020.
Amazon has shown remarkable persistence, just as it did against book sellers and retail stores. Netflix CEO Reed Hastings estimates that Amazon is spending (and most likely losing) $1 billion a year to offer streaming content to its Amazon Prime subscribers to compete against Netflix.
Amazon Prime subscribers pay $79 a year for free 2 day shipping and unlimited access to Prime’s inventory of TV shows and movies.
Overall, Amazon Prime has about half the content as Netflix, but has been growing rapidly, going from 5,000 TV shows and movies in 2011 to around 40,000 as of 2013. Morningstar analyst R.J. Hottovy estimates that Amazon Prime has about 10 million subscribers and will have 25 million by 2017.
Conclusion
Let’s take a look at how Netflix compares versus its competitors.
| P/E (ttm) | Forward P/E | 5-year PEG (expected) | Price to Sales (ttm) | Return on Equity (ttm) | Profit Margin | |
| 26.15 | 17.59 | 1.43 | 5.40 | 15.24% | 20.85% | |
| Amazon | N/A | 100.6 | 6.39 | 2.16 | N/A | N/A |
| Netflix | 613 | 79 | 8.33 | 3.73 | 3.31% | 0.65% |
| Advantage: | Amazon |
Google is the best in terms of valuation, profit margin, and price to growth, while Amazon is the best in terms of price to sales.
In my opinion, Google is the best buy because it has the tallest moat with its dominant search division. With YouTube and Google Fiber, it stands to benefit the most from the TV to internet trend.
Amazon investors will continue to capitalize on the growth of internet e-commerce.
Investors should avoid Netflix because it is extraordinarily expensive for growth ahead and could see more competition.
The article Netflix – Is There More Upside? originally appeared on Fool.com and is written by Jason Bond.
Jason Bond has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Google, and Netflix. The Motley Fool owns shares of Amazon.com, Google, and Netflix. Jason is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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