(Please excuse any grammar/spelling errors)
Here we go again.
It is the company we love. It is a stock we love to hate. Netflix.
Let’s take a look at the numbers real quick. Base on Yahoo! Finance numbers (Last twelve months):
Netflix is trading at ~40x OCF, ~69x FCF and ~70x P/E
By comparison, Apple is trading at ~14x OCF, ~162x FCF and ~19x P/E
This alone would make NFLX appear to be expensive. As an investor, you are looking for a payback period of 40 years if the company does not grow. Of course, that is not the case for Netflix. Netflix’s revenue growth has been phenomenal (23% from 2008 to 2009 and 29% from 2009 to 2010). If the company’s growth continues at the same rate, the stock is very well worth its current valuation. Investors love Netflix because of its low asset/high cash flow business model. After all, it did take down Blockbuster, the once beloved DVD rental giant. Netflix reminded us a story that we all love – David vs. Goliath. On top of that, the company continues to expand its content library. It stole Starz’s content right for basically nothing and now CBS signs on to be a content provider as well. What is not to love?
The stock’s valuation is simply too rich. Investors are too comfortable with the evolution of content delivery where Netflix is in the forefront. But much of the dark clouds have risen on the horizon:
1. Redbox is stealing from Netflix’s DVD rental business. Which is fine because Blockbuster just went under and there will be plenty of market share up for grab in that space.
2. Amazon’s entry to the streaming business – This is huge. Amazon’s might not steal Netflix’s current customers right away, but it has the ability to stomp Netflix's growth by stopping current Amazon Prime members from switching or adding Netflix’s services. I think that will hamper some of Netflix’s growth. And if Amazon is committed to this business, it would be a viable competitor to Netflix simply because it has the bankroll to compete unlike Redbox/Coinstar.
3. The content providers are catching on. We have already seen the battle between Fox (a content provider) and Cablevision (a content delivery guy). The content providers are also creating their own delivery service (ei: Hulu). Of course, this doesn’t mean they will stop selling content rights to Netflix. It only means content rights will be more expensive going forward as more competitors emerge. Will content providers start selling exclusive content rights for premium? Or will Netflix become such a viable channel that they have no choice but to sell to Netflix? I think this is the biggest question to be answered and this is where Amazon can prove to be the biggest pest to Netflix’s business. Amazon is already selling the content providers’ DVDs. So Amazon will have the same amount of leverage negotiating contracts with the content providers. Pricier content rights can only mean tighter margin going forward for any content delivery services. And let’s not forget Youtube. What will Youtube do? Will they launch their own content delivery service? And what about Apple’s iTunes and their content library? Will Steve Job offer unlimited movies/TV download plan?
While Netflix has many advantages such as brand recognition and its huge content library; the competitions and the suppliers are catching on to the new game. And those are the reasons why I think Netflix's stock is overvalued.
And of course, I’m short Netflix. What good is my analysis if I don’t put money where my mouth is?
Disclosure: I am short NFLX.