Netflix (NFLX) might be the most controversial services company in the market. The company has massive short interest, but also has a significant number of bullish investors to come to its defense. Here lately the bulls have won the battle. But the question is whether or not these gains can continue and if past gains are a result of fundamentals or speculation.
Catalysts Pushing Shares Higher
In three months, shares of Netflix went from 52-week lows to gains of 70% and a price near $100. There are signs that its rally has not been a bounce from the bottom and that it has been due to key developments and fundamental possibilities. Here are just a few of the company-changing developments/announcements that have occurred in favor of Netflix in the last three months:
- CEO Reed Hastings continues to reiterate the focus on expanding into Europe over the next two to three years; placing an emphasis on Netflix becoming a global company.
- Multiple upgrades from firms such as Morgan Stanley and Citigroup.
- Netflix announced that it will enter France in Q1 2013. This shows that the company is in fact expanding into Europe at a rapid rate.
- Rumors that Microsoft (MSFT) might be looking to acquire the company.
- Carl Icahn reveals that he owns nearly 10% of the company.
- Global Internet Phenomena report shows that Netflix accounts for 33% of all downstream traffic, more than double YouTube and far above companies such as Facebook (FB) and Amazon (AMZN).
- Netflix announces a licensing agreement with Disney (DIS), in which Netflix will receive first-run content from Disney for several years. This deal gives Netflix access to the same content from Disney's umbrella companies: Pixar and Marvel.
Upon looking at what has driven shares of Netflix, it is clear to see that the majority of its 70% three- month rally has been due to the Carl Icahn stake and the Disney (DIS) deal. Most likely Icahn had been acquiring shares while it was trading higher prior to the disclosure of his stake. Icahn has continued to reiterate that the company holds "significant strategic value" and that, because of its market position and global potential, it could continue to grow for many years.
The acquisition rumors that first pushed shares of Netflix higher have continued to be in the spotlight, thanks to Icahn. On a CNBC interview, Icahn discussed making a hostile bid, but said he would never get it. However, he continued to state his belief that Netflix is a takeover target due to it being undervalued with 27 million subscribers and low interest rates.
While Icahn continues to boast his case for a potential takeover, Hastings continues to say that the company will remain independent. Perhaps proof that the company will remain solo came with the Disney deal, a partnership that the S&P called "groundbreaking". The deal gives Netflix an edge over rising competition, providing the company with Disney movie releases nine months following theatre debuts. There are many who believe the deal will open new doors for Netflix to expand beyond streaming; but at this point, it is yet to be seen.
Bears Remain Bearish and for Good Reasons
While some people believe the rally over the last three months is a result of fundamental progress, there are many who feel confident that it was a speculative rally caused by big name investors and rumors of a buyout. These people say that, despite its gains that not much has changed with the company-and that the Disney deal, although good, may cost Netflix a little too much. With that being said, let's take a look at the top three reasons that bears are remaining bearish throughout its rally.
- With Carl Icahn acting as a cheerleader for the company, its shares were pushed higher because of his support, not because of company-changing developments.
- Amazon (AMZN) looks well positioned to potentially take market share from Netflix with its streaming services, and announced a very important streaming deal with Ebix back in October. The deal could make it easier for smaller streaming providers to gain access to content. Furthermore, Amazon continues to test its $7.99 per month option for customers to use its service; and the competition from Coinstar (CSTR) remains a concern for Netflix bears.
- Q3 earnings report showed some significant weakness for the immediate outlook of the company, indicating a continuation of high costs.
The concerns that have surrounded this company over the last three months are by all measures worthy of consideration. The shine from an investor such as Carl Icahn investing in the company is going to create some excitement, but in the process it has led investors to forget much of its struggles. The potential competition from Amazon could pose a problem, and Netflix is hoping that global growth can offset the U.S. customers that will convert to Amazon's services.
The most significant issues might be those expressed in the company's Q3 earnings report. In the report, Hastings finally admitted that rising competition is a concern and, because of the guidance, it suggests that competition might pose an immediate risk. The company lowered the outlook for net domestic streaming subscriptions from 7 million to 4.7-5.4 million. The company also has $2.1 billion worth of content liabilities due in the next 12 months, and now has a $300 million annual cost from its Disney deal. Therefore, the costs continue to rise, the margins continue to decline, and competition remains a real threat.
Despite the fact that shares of Netflix have fallen more than 60% since August 2011, the company has continued to increase its total revenue and is yet to see significant fundamental declines. The problem with Netflix has been margins, and with high costs many fear that the company will never see large profits again in its future.
There has been a common comparison made by bullish investors over the last few months, and that is to compare Netflix to Amazon. Besides both companies now having a streaming service, both also have low margins and are spending money to make more money in the future, hopefully. However, bulls must remember that Amazon is spending money by choice, and could become a highly profitable business if it were to slow down its investment. Netflix is spending excessive money as a requirement, and no one really knows what the future will hold in regards to content and pricing. Consequently, with such large gains, and so many questions, I believe the company is fairly valued and that all further performance should be as a result of fundamental performance. The "Icahn effect" was measurable and significantly moved the stock, but now it is time for the company to perform and execute in order to trade higher.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.