Ahead of Q2 earnings, it was starting to feel a little bit like a game of one-upmanship when it comes to Netflix, Inc. (NASDAQ:NFLX) stock. As Netflix stock continues to soar – it had more than doubled this year before Monday’s release – several major Wall Street firms rushed to apply ever-higher targets.
Last month, it was Goldman Sachs Group Inc (NYSE:GS) who took its price target on Netflix stock to $490. Last week, Credit Suisse AG (ADR) (NYSE:CS) did it one better. The firm’s new analyst, Douglas Mitchelson, put a $500 price target on Netflix stock.
Given the headlines, it might seem like Wall Street got firmly behind Netflix stock at the exact wrong time ahead of a disappointing earnings report. But that’s actually not quite the case. And it suggests that Netflix stock could have further to fall.
Is The Street Behind NFLX?
Mitchelson wasn’t alone in seeing upside in Netflix stock. According to Bloomberg, three analysts have targets at or above $500.
But it’s worth noting that there are 45 analysts covering the stock. And in fact, the average target price is below the pre-earnings trading price. Consensus 12-month targets of $366 (again, per Bloomberg) suggested 11% downside in NFLX – and only ~7% gains from NFLX’s after-hours quote of $343.
Indeed, two days after Credit Suisse went to $500, UBS Group AG (USA) (NYSE:UBS) pulled back. The firm cut Netflix stock to Neutral, while raising its price target to $425 from $375. Analyst Eric Sheridan wrote that the good news was “all priced in” and cited the same valuation concerns that have dogged NFLX for some time.
And the same day as Goldman’s upgrade drew headlines, smaller firm Wedbush reiterated its outbearishness. That firm has a price target of just $125 on Netflix stock — which appears far and away to be the lowest on the Street.
Does the Street Matter for Netflix Stock?
Of course, Netflix stock has had a habit of making bears look foolish. (Myself included: I thought the run was over at $200.) Wedbush analyst Michael Pachter — who’s had some wins with Zynga Inc (NASDAQ:ZNGA) and gaming stocks like Activision Blizzard, Inc. (NASDAQ:ATVI) — long has been behind the story when it comes to Netflix. Back in 2013, Wedbush “grudgingly” raised its target to $140.
But bear in mind that since then (in 2015), NFLX underwent a 7-for-1 stock split. In other words, on a split-adjusted basis, Wedbush had a target of $20 — for a stock now trading at over $400.
This is not to pick on Wedbush, or Pachter. A number of analysts have missed the Netflix story on the way up. Indeed, Netflix has been a stock where it feels like the Street constantly is catching up to the story, rather than leading it. And so the split among analysts, itself, seems unlikely to move NFLX stock more than the disappointing Q2 subscriber numbers did.
At the end of the day, the long-term performance of Netflix stock is going to come down to its content strategy. Netflix is investing billions of dollars in that content, and that’s the major reason why its free cash flow is negative. Those assets should, over time, pay off with “long tail” to subscribers in the next decade and beyond.
But that content needs to be good. And so essentially Netflix has to create quality content in unprecedented volume. The company is releasing 80 movies this year. Last year, the six biggest U.S. studios put out 94… combined.
Admittedly, the company has a huge edge in doing so, as detailed in this excellent Vulture piece on the company’s content development. It has so much data with which to make decisions as to whether to cancel, or renew, a show. Movies can be marketed to users with pinpoint precision (and no concerning data scandals, a la Facebook (NASDAQ:FB).)
If that content is solid, churn will be low, subscriber growth will continue (particularly overseas), and, eventually, Netflix will print cash. If Netflix isn’t getting a solid return on the current investments, however, this story can change in a heartbeat.
Because this now, simply put, is a massively valued company. It’s hard to believe that just 18 months ago, rumors were flying that Walt Disney Co (NYSE:DIS) was going to acquire Netflix. Netflix now is worth more than Disney — even including debt.
And that’s why the Q2 miss hurts. The case comes down to return on the company’s content investment. If U.S. subscribers are nearing a ceiling, that ROI isn’t going to be enough. A sharp deceleration in Q2 from previous growth rates suggest that all that original content might be enough to keep new subscribers — but it isn’t attracting enough new ones.
It’s why NFLX stock took a nose dive after earnings and it’s why the bullish analysts, not the skeptical ones, look foolish for once.
As of this writing, Vince Martin has no positions in any securities mentioned.
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