In a sudden reversal of fortunes, Netflix, Inc. (NASDAQ:NFLX) shares have rallied 25% over the past two months, more than making up for the anemic performance by Netflix stock during the early part of the year.
Much of the recent gains have come after the company blasted past Q3 earnings and subscriber growth estimates by Wall Street in October.
The subscription video on demand provider also exceeded top line expectations, the first time it managed to do so in six quarters.
Mellowing on Netflix Stock
Netflix stock’s latest rally has come thanks mainly to Wall Street mellowing on the company. After souring on NFLX stock earlier in the year, Wall Street is now issuing a mea culpa saying the company’s future is not as bad as it had feared. Netflix stock now sports a pretty decent Wall Street scorecard: 24 Buy ratings, 13 Holds and 7 Sells.
Meanwhile, NFLX’s mean price target has jumped from $103.98 in October to $124.10 currently, a 19% increase and slightly under the current Netflix stock price of $125.5.
Despite the rally, NFLX stock has still underperformed the market with a year-to-date return of 9% vs 10.7% by the S&P 500.
Netflix stock has become a famous battleground stock due to worries about slowing subscriber growth especially in its pivotal domestic market. However, Q3 blew expert estimates out of the water, with domestic subscriber growth clocking in at 370,000 vs the 304,000 consensus.
The international market did not disappoint either, with subscription growth of 3.2 million beating the consensus of 2 million. Mind you, that growth came in the midst of a price ”ungrandfathering,” where older subscribers with cheaper plans were automatically upgraded to the more costly standard plan.
Oppenheimer thinks that NFLX estimates on Wall Street are still too conservative and sees possible upside in upcoming earnings reports.
Famous Netflix stock bear, Evercore ISI, is the latest analyst to give a thumbs up for the stock, raising the shares to “Hold” from “Sell” citing declining competitive threats. According to Evercore’s Ken Sena:
“We find that much of the competition we feared seems to be gaining little traction, at least not to the degree necessary to merit the same level of concern.”
Here, Sena is refering to NFLX competitors Amazon.com, Inc. (NASDAQ:AMZN) and, to a lesser extent, Hulu. Amazon Prime boasts about 50 million members compared to the 86.7 million members by Netflix and 12 million by Hulu. Amazon recently unbundled its streaming video service, meaning that you don’t even have to be an Amazon Prime member to subscribe. The service also comes with some nice perks, including being a dollar cheaper than Netflix’s standard plan and it also offers 4K content.
Meanwhile, Hulu is owned by four of the six biggest cable companies. As you might imagine, it has been getting preferential treatment when bidding for content from the cable companies against its streaming rivals, leading to higher content costs for Netflix.
But a Sandvine report on internet trends revealed that NFLX pretty much dominates the streaming video space. The report ranked Netflix as the No.1 downstream application gobbling up 35.2% of North American downstream bandwidth compared with just 4.3% for Amazon Video. Hulu did not even appear in the top 20. So this essentially tells you that Netflix’s two rivals are less popular than you probably suspected.
NFLX Stock and the Spiraling Content Costs
Despite the bullishness surrounding Netflix, some long-term concerns remain, including the company’s spiraling content costs. NFLX has been investing very heavily in original content in a bid to gain a long-term content moat. So far, we can surmise that this has been working judging by the company’s healthy growth and the fact that its rivals have not been able to trouble it much.
But those heavy investments have come at a rather big cost. Netflix’s free cash flow has been moving deeper into negative territory. During the last quarter, FCF moved from a drop of $252 million in Q2 to $506 million decline in Q3.
NFLX plans to increase original programming from 600 hours currently to 1,000 hours in 2017, spending a cool $6 billion in the process. Some of the company’s original shows are ridiculously expensive: The Crown cost a staggering $130 million to produce for just 10 episodes, while The Get Down cost $120 million for a similar number of episodes.
At this rate, NFLX might be forced to continue making frequent trips to the bond or capital markets to finance its content needs. Netflix sold bonds worth $1 billion in October, and said it plans to continue borrowing in the near-future. But NFLX has a light debt load, with its $3 billion long-term debt working out to less than 10% of its market cap.
Long-term Bullishness on Netflix Stock
Wall Street’s bullishness on NFLX stock appears merited. The company happens to be in the growth phase and building its content library is the biggest cost it has to face at this stage. But judging by the company’s growth momentum, those investments are money well spent. This makes Netflix stock a prime long-term investment.
But Wall Street is known for being notoriously myopic, judging companies on the basis of quarterly performance. Investors should therefore not be surprised if the market once again sours on NFLX if the company stumbles on its Q4 projections. Netflix stock is not for investors looking to own the shares for less than one year.
As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.
