Over the last couple of years, shares of Netflix (NASDAQ: NFLX) have gone from wildly overvalued ($300), to reasonably priced ($70), to overvalued again ($130), and now back to new 52-week lows, dropping below $55 each. For the first time during this roller coaster ride, the stock appears relatively cheap if you believe it is going to be a long-term player in the streaming video market.
There is no doubt that 2012 is a transition year for the company, which has decided to turn a blind eye to its shrinking (but very profitable) mail order DVD customer base and focus on streaming video subscriber growth. Ambitious growth plans in overseas markets (Latin America, Ireland, and the UK) are using up the profits being generated from the 25 million or so U.S. subscribers the company has. In fact, spending huge amounts of money overseas has wiped away its profits completely, leading to a roughly breakeven year for earnings per share (thanks to a $400 million loss for its international business for 2012). Such heavy losses are contributing to Netflix's plummeting stock price.
That said, Netflix is growing its streaming business in every market it operates in and the company has plenty of fire power to run at breakeven for a while (cash and investments stand at more than $800 million, versus just $400 million in debt). Having broken through the $55 level to the downside, Netflix stock now sports a market value of about $3.25 billion, or less than its annual revenue. To me, this is pretty cheap and warrants investment consideration if you believe that Netflix is here to stay longer term.
Right now the U.S. business is generating about $400 million per year in operating income, or more than $6 per share. That helps understand how the company earned more than $4 in EPS in 2011, before the aggressive (and expensive) international expansion plan took hold this year. If we assume that the losses in new markets shrink as the subscriber bases grow, and eventually turn into the black (as is now the case in Canada, for instance), it is easy to see that Netflix has very strong future earnings power. It also makes the company's current $2.85 billion enterprise value look very modest.
The bullish case for Netflix definitely requires that the company continue to grow its subscriber base. So far it has done a good job on this front. When the stock was over $100 the pace of subscriber growth very much dictated how attractive the stock was. At current prices, however, one can assume a slow pace of subscriber additions and still feel comfortable with the company's valuation. At $100 per domestic subscriber, a conservative valuation of about 1.0x annual revenue (streaming-only plans cost $8 per month), Netflix's U.S. business would be worth roughly $2.5 billion, or $49 per share. Accordingly, investors today are getting the entire international business for just $5 per share. If you believe in the Netflix brand long term, this is a very cheap stock.
