Netflix (NFLX) shares dropped after recent earnings when it was revealed that investor Carl Icahn is cutting his stake in the company. However, Icahn's son, Brett Icahn and fund co-manager David Schechter are of the opinion that Netflix can rise further as it accelerates its global expansion. Carl Icahn has stated that he cut his Netflix position because it had become too big.
The claims of Icahn Jr. and Schechter also deserve a closer look, as despite trading at a P/E of more than 400 both are bullish on the company. It looks like that the two of them are analyzing Netflix along the same lines as MKM Partners, which had upgraded Netflix's price target from $285 to $370 earlier this month and stated that its market cap could reach a whopping $20 billion by 2020.
In my opinion, MKM's valuation, although wildly positive, shouldn't be ruled out. Even if the company couldn't achieve the projected $75 billion in market cap, it should get close to the figure. The reasons behind this bullish thesis aren't hard to find. First, according to MKM analyst Rob Sanderson, the video streaming market in the U.S. is worth $200 billion and Netflix's trailing twelve months' revenue is only $4.14 billion. This means that Netflix has a lot of room to grow revenue.
What would drive growth?
The company has been adding subscribers at a pretty good rate. It saw an addition of 1.3 million new subscribers in the U.S. in the previous quarter, near the higher end of its guidance of 690,000-1.49 million. More impressively, Netflix's international subscribers jumped a whopping 1.44 million. In this way, Netflix ended the quarter with more than 40 million subscribers.
The company's strategy of making its original content along with carrying content from other studios has worked well. This helped Netflix bring in revenue of $1.1 billion, at par with estimates, while earnings of 52 cents per share were well ahead of the 49 cents consensus.
Netflix has now overtaken HBO in terms of subscribers as it aims to become a web-based television network. It is reportedly engaged in negotiations with U.S. cable TV providers such as Suddenlink Communications, Cox Communications, RCN Telecom Services, and Atlantic Broadband Finance for content. If Netflix succeeds in getting itself onto cable networks and is integrated into set-top boxes, its usage would most probably increase.
A big market
Even MKM Partners' analysis suggests that the "economics of entertainment video will be redistributed with the shift to Internet-delivered services." That's probably the reason why Netflix's partnership with cable operators such as Virgin in the U.K. and ComHem in Sweden could turn out to be lucrative. Sanderson states that cable operators in the U.K. view Netflix as a "must-have" service, and as the company moves into other international markets in the future, its international subscriber count can exceed its U.S. subscriber base.
In countries such as India, where broadband penetration is still low, Netflix can find a big market. The number of households with a TV in the country is projected to multiply from around 160 million at present to 200 million in the next four years. This growth will be driven by an increase in cable digitization and direct-to-home services. Penetration in such mass markets could be a big boon for Netflix and help it grow its revenue substantially.
Analysts are also bullish about the company's prospects with as many as 12 brokerages raising their price targets on the stock. Analysts at Morgan Stanley expect Netflix to add 4.2 million subscribers in the fourth quarter. Looking forward, CEO Reed Hastings is of the opinion that Netflix can reach 60 million to 90 million subscribers internationally in the future.
Looking at such projections, it isn't surprising to see that Netflix's forward P/E ratio (for fiscal year ending Dec. 2014) comes down to a more manageable 83x. Earnings are expected to grow a whopping 136% next fiscal year and the five year annual earnings growth rate is pegged at 22.50%. This can grow over time as Netflix expands its presence internationally.
Netflix has a big playing field ahead of it and it isn't hard to see why Brett Icahn and Schechter are still bullish. As I said above, Netflix might not be worth $75 billion by 2020 as MKM suggests, but it can surely continue growing as it taps into more markets and expands its wings.