Netflix' (NFLX) stock has swelled by more than 80% following its Q4 2012 earnings announcement. Higher-than-expected streaming subscriber additions, better cost control and lower DVD subscriber losses were the primary reasons behind the stock’s jump. The price is continuing to inch higher and trades close to $180 currently.
What is driving the stock and is this sustainable?
It appears that Netflix’s stock has reaped the benefits of multiple positive developments without anyone expressing any serious concerns around the company’s future or its ability to remain competitive. Carl Icahn’s disclosure of his 10% stake, the acquisition of more exclusive content, multiple analyst upgrades and favorable trading activities have fueled the stock. But does that mean Netflix is fairly valued?
Although things are looking better than before, uncertainties around content costs and growing competition still exist. The contest for getting a share of viewers’ viewing time is no longer limited to pure-play streaming companies but encompasses individual networks, media companies and pay-TV service providers that are promoting their own streaming services. Netflix is trying to differentiate itself with its content, but over time that differentiation could be difficult to maintain. In addition to this, the high margin DVD business is declining. We cannot simply ignore the risks in Netflix' business where profits are hard to come by and customer loyalty isn’t that great.
Review Of Increasing Competition
Investors must not forget that the international business is still incurring losses and much of Netflix' value is hinged on its performance in the U.S. Its high margin DVD business in the U.S. is in decline. Although the rate of decline has slowed down, we do not foresee a case where the DVD subscriber base will stabilize, let alone grow.
As far as the U.S. streaming subscription business is concerned, the overall market growth is bound to slow and rising competition will make life increasingly difficult for Netflix. Competition will not only make it tough for Netflix to gain or retain subscribers but will also impact its margins as competitors bid up the cost of content.
Although Amazon (AMZN) is still behind Netflix in terms of content, it is evident that the company is slowly trying to close that gap. It appears that Amazon Prime’s growing subscriber base could be a concern for Netflix in the future. We believe that as of now, Amazon presents the highest competitive threat for the company in the U.S. streaming market.
Apart from Amazon, other potentially dangerous players are Comcast (CMCSA) (CMCSK), Verizon (VZ) and DISH Network (DISH). They may be lagging right now, but they can pose a significant threat over the next few years. Comcast launched its Xfinity Streampix offering in February 2012, allowing subscribers to complement existing pay-TV packages with the additional streaming service. The service is available at $4.99 per month, $3 less than what Netflix charges, and is therefore very competitively priced. Comcast stated during its Q2 2012 earnings announcement that it had doubled the titles available for streaming Streampix since the service’s launch. The company is clearly motivated to improve its streaming content as it is charging separately for it and wants to use it as one of the methods to stem pay-TV subscriber losses.
DISH Network offers the sling DVR technology to its subscribers allowing them to remotely access pay-TV programming. Adding Blockbuster streaming is an excellent move as it gives subscribers the flexibility to watch what they want, when they want and from wherever they want. The Blockbuster streaming service was launched in late 2011 and has helped DISH improve its subscriber trends. With the FCC granting DISH a waiver to build a wireless network, DISH will get more aggressive in promoting its streaming service by selling streaming devices that will work on its broadband network.
It is also interesting to note that the streaming services from Amazon, Comcast and Verizon-Redbox are priced cheaper than Netflix, which may be a concern as their content libraries develop. Lastly, let’s not forget the efforts from media companies themselves such as the joint venture Hulu as well as premium networks such as HBO.
We believe that Netflix is going to find itself surrounded with streaming behemoths in the near future, and this could pose a significant threat to its growth outlook.
Our price estimate for Netflix stands at $127, implying a discount of about 30% to the market price.
Disclosure: No positions.