Top picks 2012: Netflix

Despite management's poor decisions, the stock could double in the next 6 to 12 months.

By TheStockAdvisors Dec 28, 2011 1:12PM
Image: Hollywood (© Comstock/SuperStock)This post is one in a series in which around 50 newsletter advisors share their Top Picks for 2012

By Ian Wyatt, The 100K Portfolio

Every once in a while an outstanding company falls from grace. Sometimes it's because the market for its products has changed. Other times it’s due to external factors, such as expiring patents, a lawsuit, an unexpected catastrophic event or new competition.

And occasionally, it's just because management screws up. This is what has dragged Netflix (NFLX) down over the last five months.

Through a series of self-inflected wounds, Netflix stock fell a remarkable 77% from its 52-week high of $304. Netflix shares now trade at around $70. But I believe the stock could double in the next six to 12 months.

Netflix is a pioneer in the video rental business. The company invented the DVD-by-mail business, essentially put Blockbuster out of business, and has now expanded into video-on-demand.

In many ways, Netflix is the cable company of the 21st century. At the end of the company's third quarter, Netflix served 23.8 million subscribers -- more than any other U.S. cable or satellite company.

The company's video streaming accounts for 29% of ALL domestic, peak-hour Internet traffic. YouTube accounts for only 10%. Sounds like a great business, right? So what went wrong?

Starting in July, founder Reed Hastings and his management team made a series of poor decisions that puzzled and infuriated subscribers, increased cancellations, and damaged the good brand image that the company had built since its founding in 1997.

Chronologically, Netflix hiked its prices 60%, tried to spin off its DVD rental business under a new "Qwikster" brand that would have required DVD subscribers to re-subscribe, then canceled its Qwikster plans a few weeks later in the face of substantial subscriber backlash. By Oct. 24, Netflix had lost 805,000 subscribers.

Clearly management screwed up. But at $65 to $75, there are plenty of reasons to buy such an undervalued stock.

The company is still the clear leader in the online video streaming business. Its many licensing agreements with movie studios and TV networks are still in place.

It still offers a reasonable price. And Netflix is aggressively expanding around the world into places such as Canada and Latin America.

I expect that 12 months from now shares of Netflix will be valued at over $100. Longer term, I think $150 a share is quite reasonable.

This bullish outlook is based on my view that the company will rebuild its brand in the U.S. and gain traction as it expands around the world. While there certainly are concerns, the worst-case scenario appears to be priced into the stock.

Netflix is small enough that it would be an easy acquisition for a larger company that wants to lock up the video-streaming business.

While an acquisition doesn’t appear imminent, the potential for one will likely provide a "floor" under Netflix shares. I believe that floor is around $60 per share.

With limited downside risk and significant potential for getting things back on track, the risk-reward profile of Netflix appears incredibly attractive.

Steven Halpern's offers a free daily review of the favorite stock ideas of the nation's top financial newsletter advisors.

Tags: NFLX
Netflix once commanded a market with no competitors. As a result they were able to get fat and arrogant thus leading to the blunders of the past couple of months. I do not think they will ever come back. I consider the scenario of them wallowing around right where they are now or even decreasing until they get bought a much more likely outcome. They are facing intense competition from Redbox and even Blockbuster who are both placing kiosks all over the place and stealing away the dvd business. The kiosks present more recent movies with immediate gratification at a reasonable cost. The streaming business is also at risk. Both Amazon and Google are looking into providing streaming content in direct competition to Netflix. The licenses for that content will only become more expensive and Netflix does not have pockets as deep as either of those giants to keep their current licenses intact. I see nothing but stormy weather ahead for a company that was once bulletproof.
Dec 28, 2011 6:10PM

The author overlooks the real reason subscribers are bailing on Netflix: they are digitally streaming the product wirelessly and the major carriers have all just ended the unlimited streaming packages and have begun overcharging big-time for 3gb, 5gb, 10gb, etc... packages that used to begin at $49/month and now begin at $79/month. In comparison, AT & T is offering fiber-optic delivery of their channel packages for $34/month. For the first time in a decade, customers are piling back into the cable companies for content and using the cheapest wireless package they can get for emails only. The average Joe can no longer afford wireless broadband services and President Obama tried to tell everyone this by blocking the T-Mobile merger but to no avail. Even T-Mobile no longer has unlimited streaming. All major carriers have the same overpriced limited product and the U.S. Congress does absolutely nothing to stop it. We are getting screwed. Netflix stock is going to continue to go down, not up, because their customer base has disappeared as fast as the formerly cheap wireless broadband packages did.

Dec 28, 2011 6:14PM
NETFLIX should hook up with Sir Richard Branson and launch their own satellite into space and offer their service that way because nobody can afford to "stream" any content from anybody anymore. We have a playing field that is rigged now to squeeze every dollar out of the working man. Wireless broadband should not cost more than $30/month. Where is the money going? Executive salaries? Paying off Congress? It can't possibly cost that much to relay content wirelessly.
Dec 28, 2011 6:18PM

By the way, I streamed 3 movies from Netflix on my Sprint wireless broadband device and instantly overran my 5gb limit. I was given $500 in overage charges then allowed to get out of my contract with a refund after they admitted to changing the terms of my agreement without notifying me. It was unlimited. Not now. It's not worth $79/month just to stream 3 movies which cost me $7.99 more from Netflix. Netflix won't last without intervention by Congress and mandatory cost cuts to the major carriers.

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