Netflix (NASDAQ:NFLX) had an impressive run up (up by 35%) in the first week of October. Monday saw an upgrade from Morgan Stanley due to which the company's shares surged to $74. The shares are now back to $65 due to the Bank of America downgrading NFLX to underperform, as the stock continues to exhibit volatility due to concerns ranging from competition to international profitability and content costs. We still think that NFLX is too expensive, considering the concerns surrounding the stock.
Scott Devitt, a Morgan Stanley analyst, upgraded the stock from equal weight to overweight because he is of the opinion that Amazon (NASDAQ:AMZN) does not want to spend so much money in its streaming service to make it as appealing to customers as Netflix, priced at $7.99/month. Amazon currently has 25,000 titles (movies and TV shows) as compared to NFLX's 60,000. According to Scott, AMZN will have to pay $1-$1.2 billion to be more competitive with NFLX. At the moment, AMZN might have other priorities for spending, and only has this streaming service so that it can entice consumers to purchase other content for its Kindle Fire, which is not available under the $79/year service. Devitt also thinks that NFLX is now more careful in its content spending because of slower U.S. subscriber growth. Previously, it had been spending too much, driven by the sharp subscriptions growth in 2010 and 2011.
We think that with $3.22 billion in operating cash flows (trailing twelve months), it has the ability to spend on both improving its streaming service and on pushing for same day delivery. It plans to spend $800-$900 million in Q3 on infrastructure for cloud services. CAPEX was $1.8 billion last year. In addition, according to the Q22012 earnings call transcript, in an answer to a question regarding LoveFilm, it was said, "LOVEFiLM business is doing very well. It's growing nicely as you mentioned we continue to add content there, and we plan on having more content there over time."
So it is not just Amazon Prime that Netflix is up against - it also has LoveFilm to deal with in the U.K. and the Nordic regions. There are many other players in the streaming market as well like Hulu and HBO.
NFLX has seen a lot of volatility in recent months, which is why the Bank of America Merrill Lynch's analyst Nat Schindler downgraded NFLX stating that the "risks outweigh the rewards." The stock now has an underperform rating, down from a buy, with a $72 price target due to concerns over domestic business and the timing of international profitability. According to NFLX, the company will re-enter the red zone in Q42012 due to international expansion. The stock is down more than 10% on this downgrade. Schindler also mentioned that U.S. subscriber growth would level out sooner, and would affect 2013 estimates. According to Nat, bears continue to have concerns over rising content costs due to competition, and an emphasis on exclusive content.
Apart from the upgrades and downgrades, Moody's has placed NFLX on a review for credit rating downgrade as well. This review was triggered by developments like the move from high margin DVDs to low margin streaming business, increased competition, and Netflix's ability to pay fixed streaming payments if subscribers decrease due to competition. The result of this review can be a catalyst for positive or negative stock price movement in the near future.
In our last article, we had disagreed with the Citi upgrade for NFLX based on better customer satisfaction. We are still of the opinion that a 72x forward P/E multiple does not present a tempting investment opportunity for a company with so many concerns.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by Qineqt's Retail Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.