In the past few months, we discussed some of the costs and benefits to buying “falling knives”, stocks that seem to be heading in one direction only. There was Research in Motion (RIMM) and British Petroleum (BP) and while both still are trading at fairly depressed prices compared to their highs, it’s fair to say that buying BP has turned out into a very good deal. BP is almost 50% higher while RIMM continues to move lower with no end in sight. This week’s downtime will only hurt a company that is down and almost out.
Today though, I’d like to discuss Netflix (NFLX), a company that I discussed a few months ago with no clear opinion but has been in free fall in recent months. In fact, 3 months ago, Netflix reached its high at $304.79! Since then, the company has lost over 60% of its value! Some had said from the beginning that the stock was too expensive and sold it short. That turned out to be a bad decision for most as they shorted ahead of time and ended up losing their bet severely. Since July however, Netflix has been absolutely destroyed.
What In The World Is Going On?
As you can imagine, there are several factors to blame for this sudden and accelerated decline.
-Major Screwups: To say that Netflix has screwed up in recent months would a major understatement. The company came out with a 60% price increase in what is still perceived by many as a recession, which was not well received, then surprised and enraged its customers by announcing the split of its physical and streaming companies as the dvd shipping business would be spun out as “Qwikster” and operate independently. The feedback was so bad that after weeks of complains and public relations nightmares, the company ended up reversing course a few days ago and cancelling those plans. The harm was done however and consumers will certainly have limited trust for Netflix in the future.
-Increased Competition: Almost every “platform/website” is working on its own solution. Not only are Amazon (AMZN) and Apple (AAPL) now very much invovled in video but so are companies like Microsoft (through the Xbox), Rokio, Sony (through the Playstation), etc. That and the price increases have resulted in slower growth with even Netflix having to ddiminish its subscriber forecast by 4% (to 24M) for the 3rd quarter.
-Increased Costs: It remains unclear how much Netflix will have to pay in the coming years to continue offering what is generally the best streaming video choice out there. Content producers are getting increasing power when selling their rights because of the multitude of platforms that want to have the bigger brands available to their consumers. Those costs have been under severe pressure in recent months with many deals to be renewed. Getting key content will be a major key for Netflix and keeping those costs under control is critical.
Revenue growth might have slowed but it does remain very solid and I do think that its numbers still look solid. Estimates range quite a bit but the company is expected to bring in close to $5 in earnings per share this year and around $6.50 for next year. That implies Netflix trading at a forward P/E under 20 which screams bargain in my opinion. Revenue growth might be slowing down but I do think that it still has strong potential.
Is Netflix The New BP Or The New RIMM?
Personally, I think that while Netflix is in a situation different from both of those, it is much more similar to BP with a solid company screwing up in a big way but with a strong underlying business. Netflix is facing a lot of competition but it does have great business partnerships both with distributors and content producers. The brand is certainly damaged but over time, if they stop making mistakes, that could make a huge difference.
Also, I think that Netflix’s early moves to take market share in Canada and Latin America will pay off as competition is months or years away and that will provide a good opportunity for Netflix to gain a solid position. There are clearly hurdles but I do think it’s still a great play. Another good point is that even yesterday, Netflix reached an important agreement with the CW network to stream its shows. Agreements like this will end up making a big difference in the subscriber growth it can achieve.
Overall, I do think that Netflix looks attractive at its current valuation, how about you?