Analyst warns Netflix stock could crash 40%
Bernstein Research says increased competition and overvaluation could send shares to $180.
By Jeff Reeves
Netflix (NFLX) can do no wrong. Its stock is currently trading at over $300 a share, near an all-time high, and its original series "House of Cards" just won two Emmy awards.
But forget the bright lights and awards shows, because there may not be a happy ending for Netflix. In fact, one analyst warns that $180 is where the stock will ultimately wind up -- about 40% below current valuations.
Carlos Kirjner of Bernstein Research warns that increased competition with sap NFLX momentum and that the bottleneck caused by a lack of reliable broadband both in the rural U.S. and in emerging markets will exacerbate the slowdown in subscriber growth as competitors elbow in.
These competitors, of course, include the well-heeled Amazon (AMZN) with its Prime Instant Video, Google (GOOG) with its emerging model of paid YouTube channels, Intel (INTC) with a set-top internet cable box and the catalog of Hulu Plus, just to name a few.
I'm in agreement pretty much across the board here, and I think the waning momentum in subscriber growth will indeed send Netflix stock crashing back to earth. However, I would warn that this is not a license to bet short in the near-term with impunity.
The short interest in NFLX is creeping up again, to 7.8 million shares as of Aug. 30. . . but last time they were this high was in mid-June, before a 40% rally in Netflix stock. And remember that Netflix disappointed on subscriber growth in July, according to The Wall Street Journal, but has managed to tack on 15% since that earnings report to dramatically outpace a choppy market.
That market may not punish NFLX in the next few weeks. . . but it will correct eventually, and severely.
Remember, Netflix stock has a forward price-to-earnings ratio that is over 90 times fiscal 2014 earnings (that's right friends, ninety, as in nine-zero). That's reason enough to think twice.
And as Kirjner writes in his recent Bernstein note, by his math this valuation anticipates subscriber growth well above 45 million in domestic subscribers -- a number Kirjner thinks is only possible "in the fullness of time" and not as a foregone conclusion on the way to a bigger and bigger NFLX customer base.
Remember, last quarter Netflix had just shy of 29 million domestic subscribers, so by his math a roughly 40% increase in NFLX customers is expected -- not hoped for -- and baked in to pricing.
The nail in the coffin, however, is the emerging-markets myth that Netflix is pursuing. Here's Kirjner of Bernstein:
We believe the addressable market in Latin America today is in the order of 10 million households, limited by poor broadband infrastructure, which we do not believe will improve materially in ways that benefit Netflix, and by low income, which will prevent many households from acquiring the devices needed to fully enjoy Netflix.
This is the issue that investors really need to focus on. I have long been focused on the major investment overseas that has yet to pay off for Netflix as a key weakness facing the stock. Consider that Q1 2011 featured NFLX generating just $12.3 million in revenue overseas for a loss of about $10.7 million. As of last quarter's earnings, Netflix generated $165.9 million in revenue but a $65.8 million loss.
I know you have to spend money to make money, but how long are they going to prime the pump?
Kirjner's point that many markets may be incapable of supporting streaming video because of broadband limitations implies that this overseas cash bleed may never right itself. And when you bake in the ever-increasing cost of content for NFLX that places pressure on margins, tough competition at home and the nosebleed valuation with no margin for error... well, the risks become very clear.
Remember, just one year ago Netflix was trading for less than half the $180 target plotted by Bernstein's team. If you bought Netflix stock in early 2012, you still made a good choice and nobody can take that away from you.
But selling right now in 2013 as the stock trades above $300 could be an even better one; protect your profits and sell NFLX now if you own.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.
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