Streaming Video Promises 15% Upside for Netflix Stock

| About: Netflix, Inc. (NFLX)

Netflix (NASDAQ:NFLX) is moving aggressively to improve its streaming video service by adding titles and including more recent releases.

The company recently signed a multi-year distribution deal with Epix, a premium TV and broadband channel operated by MGM (NYSE:MGM), Lionsgate (NYSE:LGF) and Paramount Pictures, a division of Viacom (NYSE:VIA). The deal will allow Netflix to stream new releases and library titles from MGM, Lionsgate and Paramount over the Internet.

Under the agreement, Netflix subscriber will likely be able to watch Epix movies starting 90 days after they debut on Epix’s pay-TV and subscription video-on-demand channels. Netflix will probably start streaming Epix movies in early September.

The Epix deal follows similar Netflix deals with Starz and Relativity Media. If streaming media adoption exceeds our expectations going forward, Netflix’s shipping costs could go down significantly starting in 2013. In this scenario, we see a potential 10% to 15% upside to the $85.06 Trefis price estimate for Netflix’s stock price. Our analysis follows below.

Fresher Content

As Netflix’s online library grows in both quantity and quality, we think it’s only a matter of time before subscribers are predominantly watching movies online. In the short term we expect the total volume of physical DVDs shipped by Netflix to increase due to the company’s rapid subscriber growth. This will contribute significantly to Netflix’s costs.

However, we note that the average number of DVDs that Netflix mails monthly per subscriber has declined in recent years. We expect this decline to continue going forward, from about six DVDs a month today to about 4.5 a month by the end of the Trefis forecast period.

You can drag the trend-line in the chart below to create your own forecast for DVDs mailed per subscriber and see how it impacts Netflix’s stock price.

We see the Epix, Starz and Relativity Media deals as a portent of things to come. If Netflix can sign more streaming deals with content providers, its shipping costs should go down and free cash flows should increase. In this scenario, we think Netflix’s total DVD shipments could start trending downward in 2013, yielding a 10% to 15% upside to our stock price estimate.

Aside from the obvious cost savings, Netflix’s reputation benefits from streaming media deals that allow it to deliver desirable content at the customer’s convenience and at minimal cost. Netflix is already the market leader in this area. As it signs more deals with premium content providers like Epix, we see significant potential for Netflix to add more subscribers and reduce subscriber churn.

Disclosure: No positions