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A Foolish Call on Netflix and Coinstar

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

On Wednesday shares of Netflix (NASDAQ: NFLX) led the S&P 500 in performance, with its near 8% gain after Citigroup analyst Mark Mahaney restated his “buy” rating. Mahaney cited that a reasonable valuation, a generally positive execution track record, and an early market opportunity for internet streaming makes the stock a buy. However, I can’t help but to feel that there’s a sucker born every minute, and that hopefully investors are simply trading this stock and are not buying into this new found level of “hype,” especially when greater value exists elsewhere.

Netflix and Groundhog’s Day

I won’t deny, that in 2010, and even during the first couple months of its fall in 2011, I thought Netflix was a buy. And over the last year there have been several points in time where I have started to believe that just maybe Netflix has bottomed and would make a good investment. But just recently, last month, the stock hit a new 52-week low, and has now bounced off the bottom with a three day rally.

The stock’s recent performance reminds me of last quarter, before earnings, when the company’s CEO Reed Hastings “mentioned,” on Facebook, that streaming hours had crossed the billion hour mark. This led to optimism and a belief that the company would exceed earnings expectations, but it did not.

Over the last year, throughout its fall, there have been several instances where it would bounce from lows on some random outlook that suggested upside for the company. It has often traded higher before earnings, as there are many who simply want to believe in the future of this company. It is a non-traditional technology/services company that we want to succeed. And because of a large market potential in emerging markets and a fallen stock there are many who try to call the bottom and are attempting to ride the stock back to its days of glory. However, on a one-year chart it is still trending lower, there are still too many questions, and there is no reason to believe in the recovery of this company. But at this time, Netflix is a stock that has repeated the same pattern over and over and over of trending lower only to bounce from lows with the idea of upside, which in the past has occurred before earnings.

A Foolish Call

No one can deny the company’s incredible run from $5.40 in 2003 to $300 in 2011. This run was a result of fundamental growth and proper execution, but in recent memory “positive execution track record” is the last thing we can connect to Netflix. Think back to last year, it was the decision to separate the company’s streaming and mail order program that led to such a rapid decline. If we look at the fundamentals of Netflix we’d realize that this is a company that continues to grow. The company’s last quarter was a record in revenue. Therefore, with proper execution the stock may have remained above $250. Just look at Amazon (NASDAQ: AMZN). It had several quarters of revenue growth and depressed margins, but continued to trade with a gaudy valuation as investors believed in its future. If Netflix would have demonstrated proper execution and had given a clear business plan then it may have experienced a similar fate, but instead appeared desperate and uncertain regarding its own future.

Right now I see no reason to invest in Netflix, until a clear picture of its future is realized. I am not saying that Netflix won’t appreciate or continue to grow, but the questions that led its stock lower still remain. Therefore, I suggest going a different direction and investing in a competitor: Coinstar (NASDAQ: OUTR).

One of Mahaney’s reasons for a “buy” rating was Netflix’s reasonable valuation. Netflix may be cheaper than it was in 2011, but is nowhere near the value being presented in shares of CSTR. When you compare the two companies side-by-side there really isn’t a strong case to buy NFLX. Take a look at the chart below to see how the two companies compare:

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>Netflix</p> </td> <td> <p>Coinstar</p> </td> </tr> <tr> <td> <p>Market Cap (billions)</p> </td> <td> <p>$3.37</p> </td> <td> <p>$1.40</p> </td> </tr> <tr> <td> <p>Revenue (last 12 months)</p> </td> <td> <p>$3.46 billion</p> </td> <td> <p>$2.09 billion</p> </td> </tr> <tr> <td> <p>Net Income (last 12 months)</p> </td> <td> <p>$99.26 million</p> </td> <td> <p>$159.22 million</p> </td> </tr> <tr> <td> <p>Price/sales</p> </td> <td> <p>0.91</p> </td> <td> <p>0.66</p> </td> </tr> <tr> <td> <p>P/E ratio</p> </td> <td> <p>33.43</p> </td> <td> <p>9.31</p> </td> </tr> <tr> <td> <p>Forward P/E ratio</p> </td> <td> <p>66.49</p> </td> <td> <p>8.35</p> </td> </tr> <tr> <td> <p>Revenue growth (recent quarter)</p> </td> <td> <p>12.8%</p> </td> <td> <p>22.30%</p> </td> </tr> <tr> <td> <p>Income Growth (recent quarter)</p> </td> <td> <p>(91%)</p> </td> <td> <p>37.90%</p> </td> </tr> </tbody> </table>

 

As you can see, Coinstar trumps Netflix on every measure of fundamental growth and valuation. Netflix is seeing margins decline while Coinstar is improving its margins, while growing sales and profits at a faster rate. Coinstar also trades with a more attractive valuation and is expected to post earnings growth over the next year. Netflix, on the other hand, is expected to see income loss over the next year, with a forward ratio of 66.49. Therefore, I find it difficult to believe that Netflix has a reasonable valuation with next year’s P/E ratio at 66.49 and mediocre sales growth.

The Netflix bull will argue that NFLX will trade higher because of its expanding presence in global and emerging markets, which could result in much larger profits. However, keep in mind that Coinstar has teamed with Verizon to provide streaming movie sales and rentals by the end of the year. This new service will be called “Redbox Instant” and is 65% owned by Verizon. It will be a limited risk venture for Coinstar, but gives the company access to a much larger market, a market that is currently owned by Netflix.

Foolish Conclusion

As with all investments due diligence is a must. Netflix has the opportunity to grow in global markets but with increased competition from companies such as Coinstar and Amazon it may lose U.S. subscribers in the process. At this point there is not enough diversity to the business model of Netflix, and for so many questions the stock is still expensive. I prefer a diversified business such as Coinstar, a company with an attractive valuation, strong growth, and a number of upcoming catalysts that could lead to significantly larger gains. The company’s Redbox Instant could be a huge success, and other new features such as the sale of tickets for live events at Redbox machines could also add value. As for Netflix, I just don’t see the same upside, it’s a black and white business, with DVD rentals and streaming services, and with its competitors continuing to innovate I doubt its trend lower has reached a bottom. 

Dig Deeper

The precipitous drop in Netflix shares since the summer of 2011 has caused many shareholders to lose hope. While the company's first mover status is often viewed as a competitive advantage, the opportunities in streaming media have brought some new, deep pocketed, rivals looking for their piece of a growing pie. Can Netflix fend off this burgeoning competition, and will its international growth aspirations really pay off? These kinds of issues are a must know for investors, which is why The Motley Fool released a brand new premium report on Netflix. Inside, you'll learn about the key opportunities and risks facing the company, as well as reasons to both buy and sell the stock. They’re also offering a full year of updates as key news hits, so make sure to click here and claim a copy today.


BrianNichols has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com and Netflix. Motley Fool newsletter services recommend Amazon.com and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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