Netflix (NFLX) Pushing the Envelope Both Today and in the Future

Netflix (NFLX) announced today that surpassed the ten million subscriber threshold and its pace of subscriber gains has recently accelerated . At the end of 2007 it had 7.47 million subscribers and grew at about 25% (to 9.4 million subscribers) in 2008. Now, in just over a month, the company has gained 600,000 subscribers so far in 2009. Netflix pioneered the movie-by-mail subscription service, and the concept obviously has appeal in the current economic down-turn as consumers are staying home more than in the past. Blockbuster (BBI), long thought of as the standard in the movie rental business, has reluctantly adopted the subscription service model in order to stay alive. BBI is struggling to catch up with Netflix and has been shuttering stores in order to cut costs in a further shift to the by-mail model.

NetflixNetflix was visionary in creating the by-mail movie rental model and they appear to be getting it right again by anticipating the next wave in rental entertainment: streaming video. The internet has changed the way we conduct business, communicate, shop, and entertain ourselves, so it is not hard to foresee that the expanding capabilities of the web will continue to make more services available via the internet. Netflix was the first to introduce on-demand steaming movies in January 2007 and being on the fore-front of the next wave is a big reason why Netflix continues to outpace Blockbuster in subscriber growth. Netflix has established strategic partnerships with Microsoft (MSFT) (streaming video through its XBox 360 game console), LG (Blu-ray players and high definition televisions), Vizio (high definition televisions), and Roku (set top boxes).

As the world continues to become more inter-connected through broadband internet, Netflix stands ready to remain the dominate force in movie rentals. Of course, there will be competition from Blockbuster who is still building its streaming rental business and Amazon.com (AMZN) which has a good ala carte rental system, but there is little doubt that Netflix is well positioned to remain number one. As broadband penetration continues to grow ($5.6 billion is ear-marked to expand broadband in the U.S. in the most recent version of the stimulus plan), there are ever more potential customers for Netflix.

The beauty of the Netflix model is that when times are tough people see Netflix as a way to save a buck. Skip the theatre, watch a move at home, pop your own popcorn and you have already saved enough money to pay for a month’s subscription. When the economy improves people will see Netflix as a relatively inexpensive luxury and the monthly recurring credit card charges for movies can easily slip one’s mind. The model appears recession-resistant and provides instant access that the internet age requires.

Netflix stock has had a really nice run in a woeful economy–the stock is up nearly 40% year over year and up more than two percent today in an otherwise down market. Despite its run up, we do not believe the stock is Overvalued given its current price-to-cash flow and price-to-sales metrics. Both numbers are in line with historically normal levels and there are no other red flags in our analysis, which accounts for the stock’s Fairly Valued rating from Ockham at its current price. With the recent success of Netflix and the forecast for continued strength, were there to be any significant pull-back in NFLX, we would not hesitate to recommend the stock.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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