Netflix play gives Street pause

Empty

When Netflix reports its first-quarter earnings April 21, investors will be looking for clues as to whether the company can sustain the sort of momentum that has made it one of the strongest performers this year on The Hollywood Reporter Showbiz 50 stock index.

It's a tough call. Although the stock is up 37% so far this year and is the recipient of at least seven upgrades in the past eight months, the median price target among the 13 analysts covering the stock is just $32. That's 12% below Wednesday's closing price of $36.42.

The most bearish analyst thinks the stock is headed for a 67% fall to $16 this year, while the most bullish analyst, Derek Brown of Cantor Fitzgerald, recently set a $41 target on shares.

Brown admits being late to the Netflix party, going from a "hold" recommendation to a "buy" only last month and missing much of Netflix's gains this year. His thesis changed as a result of Blockbuster's switch in strategy to focus on profit, as opposed to gaining subscribers, for its by-mail service that competes with Netflix.

He also has come to the conclusion that bears who predict VOD and digitally delivered movies will hurt Netflix are wrong given the film industry's "glacial transition" to those models.

Brown noted that the short interest in Netflix's shares is at a hefty 30% of the float because of those fears of digital competition from the likes of Apple TV, TiVo-Unbox and others. Buying back all those shares that have been shorted will juice the stock higher still.

Longtime bull Rick Munarriz of the Motley Fool agrees, noting that "VOD has been around longer than Netflix and it hasn't slowed them down yet."

Netflix was born in 1997, launched its service in 1999 and became a public company in 2002. Munarriz has been a shareholder since the stock traded at $6 a few months after its initial public offering.

Munarriz said Netflix investors need not worry for several years about digitally delivered movies harming the company's business. As for the upcoming quarterly results, "there's no meaningful digital product that came out in the last year, so as long as they keep their churn in check, they'll be fine."



That churn, once at more than 7% early in its history, was at 4.1% in the fourth quarter, down from 4.2% sequentially but up from 3.9% year-over-year. Brown is predicting low churn this year, culminating in a record-setting 3.7% in the fourth quarter.

Subscribers, meanwhile, have surged from 1.5 million in 2003 to 7.5 million in its most recent quarter, and CEO Reed Hastings predicts as many as 9.5 million by the end of the year. By comparison, Blockbuster had 3.1 million subscribers in its most recently reported quarter and said it would no longer disclose such numbers going forward.

As for digitally delivered movies, if the format ever does gain traction, Netflix is positioned with what it now calls Browse Instant, which allows for on-demand viewing of 8,000 movie and TV titles (as opposed to 90,000 titles on DVD).

Netflix intends on striking deals to put its Browse Instant service into consumer electronics devices so that subscribers can view movies not only on computers but also on TV screens. One such deal, with LG Electronics, already is in place.

Also, Hastings, who declined an interview request citing a quiet period ahead of the quarterly earnings report, is on the board of Microsoft, so investors are looking for Netflix movies to eventually come to the Xbox.

There are a couple of red flags that Munarriz noticed recently, though, specifically in Netflix's revised guidance in February that was met on Wall Street with enthusiasm.

The company upped its per-share profit outlook, its subscriber estimates and revenue guidance. Two potentially worrisome oversights he noticed were: It did not raise its net income projection, and it raised its sub guidance a lot more than its revenue guidance.

Blu-ray is another short-term wild card. While that next-generation DVD technology's victory over HD DVD eventually will boost Netflix's fortunes, the demise of HD DVD means Netflix might have over-invested in that suddenly outdated technology.
comments powered by Disqus