Seeking Alpha
Long/short equity, tech
Profile| Send Message|
( followers)  

Netflix (NASDAQ:NFLX) has certainly had its ups and downs in the past, but in my opinion it has done an admirable job of translating its business from DVD rentals to primarily online streaming, and has become the 800lb gorilla of streaming, what "fools" like to call a first mover. Additionally, Netflix became the single biggest source of web traffic in North America back in 2011, and now mobile traffic has almost doubled in the last 12 months.

The price woes of Netflix stock are clearly linked to the announcement to separate the DVD and streaming services, which occurred on July 12, 2011. This announcement was quickly followed by a strong downdraft in the stock price, and in October of the same year Netflix announced that it had lost 800,000 subscribers in Q3, the quarter in which the split was announced. NFLX also reversed the decision to split DVD rental into Quickster, and said that the DVD rental arm would remain within the NFLX brand.

By the beginning of 2012, NFLX announced that they had recovered the lion's share of the subscribers lost during Q3 2011, and things looked up a bit until, in April 2012, they formed FLIXPAC, a political action committee which wasn't well received, and the stock price plunged once again. It appears that investors saw NFLX having a crisis of identity during this period, with anger by subscribers over increased cost to the consumer with a split between DVD and streaming. EPS also plunged during this period, going from a robust $1.26 in Q2 2011, to an anemic -$0.08 in Q1 2012. Even so, EPS was consistently better than consensus estimates.

By Oct 2012, the NFLX stock price began to turn around. Service in Canada, the UK, Ireland, and Central America was already in place, and Norway, Denmark, Sweden and Finland were to be added by year end. While concern over NFLX killing the golden DVD goose continues, the fact is that revenue from the DVD subscriptions has fallen continuously since mid-2011, while streaming revenue continues to increase, accounting for roughly 70% of NFLX revenue at this time, and no wonder, who wants to wait for the mail man when a click of a mouse provides instant gratification? In spite of the reduced DVD revenue, overall revenue continues to climb as streaming supplants renting.

Since bottoming on August 3, 2012 at 52.81, NFLX has flown. Their waffling business plan has solidified, they continue to add content, including original content, and the recent 14 Emmy Nominations for that original content shows that NFLX can compete with the big boys, perhaps even surpassing Jeffrey Bewkes' Albanians.

For the past 3 years NFLX has consistently shown positive surprise on its earnings, and has been rewarded for it, with the exception of that period roughly defined between July 2011 and July 2012 when NFLX was trying to find itself. Revenue has grown consistently, so there's no reason to expect that EPS will not continue to make a comeback from its former drop.

(click to enlarge)

Technically, the events above are obvious in the chart, and NFLX's return to a profitable model has been handsomely rewarded in the past year.

(click to enlarge)

NFLX has broken through nearly all resistance levels approaching the $300 mark of its former glory. There remain minor resistance levels at 270, 280 and 290, but they really are minor, and beating the EPS estimate of $0.40 could blow the price right past that resistance.

Initial reaction to the report was a mild pull back, and that's just fine, I would prefer to see the stock price advance in an orderly fashion rather than continued gaps up as the past 2 reports have prompted.

(click to enlarge)

Should the price of the stock move beyond the 300 dollar mark, I would expect to see the price rebound from a new high to test the 300 dollar level. If the $300 level holds, I think that the price continues to climb, and if not, then a retracement of the run over the past year would be in order, however, given NFLX reporting history, I expect that the numbers will at least be in line, most likely better, and we can continue to see NFLX improve subscription, content and revenue.

There are, of course, a number of "also ran" companies such as Amazon (NASDAQ:AMZN), Walmart (NYSE:WMT), Verizon (NYSE:VZ), Apple (NASDAQ:AAPL), Hulu and Roku, to name a few, trying to break into the action. Many argue that they will be the death of NFLX, but in my view, they have seen the promise of streaming and want a piece of the action, so rather than being a great concern for NFLX they represent confirmation of the streaming concept, however, those others haven't gotten it right, at least not yet in my opinion. Verizon has video on demand, but my personal experience is that selection is poor and rotates quickly, so don't blink or you will miss what you wanted to see. Verizon is also teaming with Redbox in an effort to improve. Amazon and Apple have severe price model issues in my opinion, and I'm not willing to pay through the nose to stream TV or movies. I have Verizon FIOS, and my family of 5 hardly ever watches that overpriced content. I've had HULU PLUS as well, and what has everyone in the house been watching? Netflix. Verizon's VOD is annoying at best, with their extremely limited selection and slow interface connection speed. HULU is just plain annoying. Back in the day we suffered commercial television because it was free. Why on Earth would I want to pay to stream commercial television if I could avoid it?

NFLX is fast, has a good, if not excellent interface with an excellent recommendation algorithm. It is true that NFLX does not necessarily have the latest shows, but that is changing. When I first subscribed just a short 12 months or so ago there were very few programs that I normally watched on cable available, but now there are many, and it continues to improve. The lack of front running programs was actually a blessing, as we discovered many jewels that we otherwise might have missed such as Midsomer Murders, Good Guys, Life, Heroes, etc.

Netflix's overall trend looks good, and there appears to be room to run higher.

(click to enlarge)

EPS has moved well with the price movement since before the $300 high, showing a reduced likelihood that NFLX is in a price bubble.

(click to enlarge)

In conclusion, NFLX is the number one streaming service by volume with the largest content library.

Netflix is also the single largest bandwidth user on the internet. The stock price took a hit in 2011/2012 due to lack of direction, but it has since recovered the bulk of that loss, and stands at the cusp of regaining its former valuation glory. Its valuation is very high, the highest, by far, in its sector, but it deserves that valuation because of the promise that it shows and because others in the sector are laggards, not the other way around.

Disclosure: I am long NFLX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Thanks to the SA editors for their help and patience.

Source: Why I'm Long Netflix