Netflix (NASDAQ:NFLX) Merriman downgrading to Neutral on near-term margin pressures and limited upside to target
Netflix ran up to a new all time high yesterday on news of expanding into Latin America and Carribean. As such they confirmed what had been expected since earlier this year – that the most likely region for international expansion would be be Latin America. This is believed to be a very attractive market of broadband subscribers with expanding wealth due to less competition than in Europe or the UK. Netflix will offer its streaming-only subscription plan into 43 Latin American and Carribean countries during 2H11.
Merriman estimates that there are more than 40M broadband subscribers throughout Latin America and the Carribean, and given the 4% broadband subscriber penetration already achieved in Canada during the first 9 months, they see 5-10% penetration rate within the new regions during the first year. This would yield 1.9-3.8M subscribers and $180-360M in annual revenues(assuming $8.00/month subscription price).
Netflix seen to be entering a period of restrained operating margins. Although on the Q1 conference management increased their anticipated 2H11 operating losses from this year’s international launch to $50-70M from $50M, the analyst believes the projected Y/Y declines in operating margins for at least the next year could begin to negatively impact investor perceptions of growth trends and appropriate valuation multiples.
Company could see increased international spend guidance as management has already increased the anticipated operating loss range with a likely desire to lock-up key content to gain a head-start over potential competition it would not be surprising if management increased the operating loss guidance again. While this decision would be positive for Netflix’s long-term growth prospects, the analyst believes it would cause a near term shock to current earnings estimates and the valuation multiple.
Merriman’s current valuation range of $300-330 is based on a P/E multiple of 45-50x FY12 EPS estimate (or a 1.0x PEG ratio). After the 89% increase in NFLX shares since their upgrade they now see less than 10% potential upside to the target valuation range. The analysts upgrade was based on the prospects of international expansion, which has now played out.
The analyst is recommending swapping into CSTR as a play on the ongoing transition within the physical home video segment along with a wild card on the pending announcement around Redbox’s digital strategy and partner. He recently boosted the EBITDA estimates above guidance and consensus following a thourough analysis of 2011 DVD rental potential and he sees additional quarters of revenue/EPS upside near-term. Using a very conservative 5.5-6.0x FY12 EBITDA estimate multiple he believes CSTR shares can reach a valuation range of $72-79 (27-40% upside).
Notablecalls: You probably won’t believe this but Merriman can actually move this name. Merriman had the Street high $300-$330 valuation range when the stock was in the low $200’s.
What I like about this call is that it isn’t too pushy. The analyst has been right but his is now becoming more hesitant regarding the upside. Tough yoy compares coupled with high valuation is not the best combo for a mo-mo stock.
Lots of trapped shorts there but the stock should come down on this. I’m thinking 285-280 range in the n-t.
This is the last thing people expect it to do, right?
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