Netflix, Die Alone or Soar on Potential Acquisition

Netflix, Die Alone or Soar on Potential Acquisition

Netflix, Inc. (NASDAQ: NFLX)   10/30/2012                         Last Price: $69.58

VIEW:  SELL

Netflix operates a video streaming service available in the U.S., Canada, and certain countries in Europe, Central, and South America. Netflix delivers digital content to PCs, Internet-connected TVs, and consumer electronic devices including but not limited to the Xbox 360, Playstation, and Wii. In 2011, Netflix introduced DVD-only plans and separated the combined streaming and DVD plans, making it necessary for subscribers who want both to have separate plans.

Sector: Services                                                                                                Industry: Music and Video Stores

Highlights:

Netflix (NASDAQ: NFLX) is the world’s largest video and television episode rental subscription service, having pioneered the model and charging customers a flat monthly fee for unlimited rentals without due dates, late fees, shipping fees or pay-per-view fees. The stock closed yesterday’s trading session at $69.58. In the past year, the stock has hit a 52-week low of $52.81 and 52-week high of $133.43. Technical indicators for the stock are bullish for the short term but the company’s fundamental ratios are not promising.

GROWTH AND BALANCE SHEET

Netflix disappointed investors and Wall Street after reporting results down 88% from last year’s Q3. Annual earnings growth rate over the past five years is 42.53%, but we believe that is not sustainable for the future, unless the company team up with the big guys like Microsoft or Amazon. The total Debt/Equity of 55.80% is rather high but acceptable for the industry.

VALUATION

Netflix has more than 30 million streaming members globally including over 25 million in the U.S. and is currently available in 51 countries. It has strong collection of content, and this make the company a valuable target acquisition for bigger players such as Amazon, Microsoft or Google who are willing to bet on the future of streaming. NFLX has a PEG ratio of 72.26, at the industry average. The P/E of 89.78 is very high and above the industry average. The stock is currently trading above its fair value of $55. The beta of 0.81 implies low volatility of the stock with respect to the S&P 500. The separation of its DVD and streaming services make many customers to leave Netflix because of the higher prices that followed the decision.

RECOMMENDATION for next 6 months: We initiate our coverage with SELL. The company has reach maturity level and will fail to materialize the targets for global expansion due to intense competition and luck of cash flows. An acquisition may be the best possible scenario for Netflix investors at this point. Shares are up 0.42% year to date as of the close of trading yesterday.

As the company is a very attractive target for acquisition from bigger companies, and we want to play this scenario in the short term, we suggest a long call at $75 strike price January expiration at $5.10 per contract.

NEWS and CALENDAR

01/23     Earnings Release

Tuesday October 30, 2012 – East Coast Netflix viewing doubles during Sandy

Friday October 26, 2012 – Rumor: Microsoft Still Interested in Acquiring Netflix

Friday October 26, 2012 – Facebook Flies And Netflix Flops: The Short (Selling) Story

Tuesday October 9, 2012 – Analyst Moves: HPQ, NFLX

NFLX Strengths

• Proliferation of Netflix-ready devices adds value to Netflix’s digital streaming service
• Size of subscriber base gives Netflix negotiating leverage for content
• wii movies
• strong expansion

NFLX Weakness

• Lost and defective dvd’s costs
• Amazon breaking into movie rental
• First Release Time Delay
• Strong competition

Competitor Comparison    NFLXAMZNIndustryMarket Cap:3.86B107.91B110.72MEmployees:2,34856,21.74KQtrly Rev Growth (yoy):0.100.270.00Revenue (ttm):3.54B57.26B506.43MGross Margin (ttm):0.290.240.31EBITDA (ttm):146.56M2.09B21.01MOperating Margin (ttm):0.030.01-0.01Net Income (ttm):44.47M40.00MN/AEPS (ttm):0.780.080.01P/E (ttm):89.782,836.198.80PEG (5 yr expected):72.2643.1072.26P/S (ttm):0.971.761.09

Stock valuation model

The model rates stocks from 1 to 10, with 10 being the best using a system of advanced mathematics to determine a stock’s expected risk and return. I am using different fundamental and technical factors in order to rank a stock.

Intrinsic value of the stock

Investors should buy stocks selling at a discount to their intrinsic value, and then patiently wait for the fair value of their investments to be realized.

NFLX’s intrinsic value is $55.00 the current price is $69.58, the stock trades well above its fair value.

Financials

The financial health of the company the higher the better, we evaluate all the financial ratios of the company.

Sentiment

Investor’s sentiment for the stock

Analyst ratings

The model assigns a value according to analyst’s recommendation for the stock.

Earnings Consistency

We are searching for EPS numbers that are better than the previous year’s. One dip is allowed, but the following year’s earnings should be higher than the previous year. NFLX’s annual EPS before extraordinary items for the last 5 years (from earliest to the most recent fiscal year) were 0.97, 1.32, 1.98, 2.96, 4.16, this type of earnings action is favorable as there is yearly growth

Total Debt/Equity

The company must have a low Debt/Equity ratio, which indicates a strong balance sheet. The Debt/Equity ratio should not be greater than 20% or should be less than the average Debt/Equity for its industry

NFLX’s Total Debt/Equity of 55.80% is acceptable as the industry average is 800%

Quarterly EPS Change (This Quarter VS. Same Quarter Last Year)

The EPS growth for this quarter relative to the same quarter a year earlier is above the minimum 15% that this model likes to see for a “good” growth company. Stocks with improving earnings are worthy of your extra attention.

NFLX’s EPS growth for this quarter relative to the same quarter a year earlier is -88.70% well below our target.

Annual Earnings Growth

This stock valuation model looks for annual earnings growth above 12%, but prefers higher than 20%.

Netflix annual earnings growth rate over the past five years is 42.53%, well above our target growth.

Current Price Level

Traders should keep an eye open for stocks that are trading within 10% of their 52-week highs, as it is likely to continue in its upward trend.

NFLX’s 52 week high is $133.43 current price is $69.58, is 91% below the 52 week high.

P/E Ratio

The Price/Earnings (P/E) ratio, based on the greater of the current PE or the PE using average earnings over the last 3 fiscal years, must be “moderate”, which in this model states is not greater than 15. Stocks with moderate P/Es are more defensive by nature.

The company has a P/E ratio of 89.78 the average industry P/E ratio is 8.80 and well above the S&P 500 P/E ratio of 16.30

Insider Ownership

When there is strong insider ownership which I define as 12% or more, management is more likely to act in the best interest of the company, as their interests are right in line with that of the shareholders.

Insiders own 12.93% of NFLX stock. Management’s representation is large enough. This does satisfy the minimum requirement, and companies that pass this test are more attractive to our valuation model.

Technical Analysis

The model is using several technical indicators (MACD, RSI, MFI, OBV, position Indicators) to forecast the trend of the stock for 6 and 12 months, and assign a value.

NFLX formed a bullish Gap Up signal and the average volume increased over 5%, the money Flow Index is bullish. Our overall technical analysis view is bullish for the stock.