This Streaming Business is Already Overvalued

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

Up more than 42% in one trading day! When first hearing the news, I thought it was either a penny stock’s movement or a rise after buyout news. However, that significant increase was due to a positive quarterly earnings announcement of a mid-cap stock named Netflix (NASDAQ: NFLX). For the last 4 years, Netflix has been one of the most volatile stocks in the market. Its share price went from around $30 in 2009 to nearly $300 in the middle of 2011, and then it dropped to $54 in September 2012. With the current trading price of $147 per share, Netflix has gained more than 270% in just 5 months.

A Quarter with Growing Subscriptions

Its 2012 fourth quarter results were quite impressive. The revenue was $945.2 million, 7.9% higher than revenue in the fourth quarter last year. EPS came in at 13 cents a share, beating Wall Street estimates of a loss of 13 cents. In 2012, the global streaming members have grown by nearly 10 million to more than 33 million. In Q4, the number of net subscriptions in the US increased by more than 2 million to 27 million. The contribution margin rose to 18.5%, the highest level in the past 5 quarters. The company explained that the margin expansion was due to more members, higher revenue, and lower content delivery costs. Although Netflix beat the estimates in the fourth quarter, it fell short of the goal to grow its domestic streaming subscriptions by 7 million. For the full year, the domestic streaming subscriptions went up by only 5.48 million.

Best Content and Highest Subscribers

The negative non-GAAP free cash flow of -$51 million was due to large amount paid to acquire contents for its streaming library. In the fourth quarter Netflix paid out more than $631.6 million for additions to the streaming content library, bringing the total cash payment for streaming content additions to $2.51 billion in the full year 2012. Indeed, the company has signed quite a few content deals, including Walt Disney, Time Warner, and HBO. Amazon Prime from Amazon (NASDAQ: AMZN) also struck a deal with A&E Network to stream shows such as “Pawn Stars,” “Dance Moms,” and “Storage Wars.” After the deal, subscribers of Amazon Prime could stream more than 33,000 movies and TV episodes. Netflix said that compared to other peers such as Redbox Instant (the joint venture of Coinstar (NASDAQ: OUTR) and Verizon), Hulu Plus, and Amazon Prime, Netflix was still the best with the most popular content. 

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Source: Netflix’s Q4 12 Letter to Shareholders

The company had examined the top 200 titles in its content library, including the 100 most popular movies and the 100 most popular TV shows in the fourth quarter. Out of these 200 titles, all of the other three peers combined offered only 87 titles. Hulu Plus offered 27 titles, Redbox Instant offered 12 titles, and Amazon Prime had 73 titles. Among the three, Netflix had the highest number of subscribers, at 33 million. Amazon Prime had around 9 million subscribers, less than a third of Netflix’s, whereas Hulu had much less, with only 2 million. Redbox Instant had around 10,000 users for its public test and it saw the potential for 35 million customers. However, Redbox Instant mentioned that it was not the Netflix killer because DVDs were its core. Indeed, it could leverage the existing Redbox’s DVD rental business. 

Foolish Takeaway

Even with the surprisingly good quarter, I think Netflix was overvalued at the current trading price of $147 per share. The market is valuing the company at as high as 36.4x EV/EBITDA and a PEG ratio of 14.6x. I believe that investors are being too optimistic this time. 

hoangquocanh has no position in any stocks mentioned. The Motley Fool recommends and Netflix. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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