Netflix (NFLX) stock rose nearly 4% on Tuesday, after Imperial Capital Managing Director David Miller made a bold projection of potential 30% upside over the next 12 months for the company. That's a $503 price target for those of you that have a life and don't stare at stocks all day.
Barring a big market pullback, I do think Netflix can hit that target. However, I think they'll have a hard time keeping it over the long term. There are reasonable concerns over competition, and the long-term ability of the company to maintain its foothold. On top of that, stock doesn't exactly come at a cheap price. The current valuation is well over 200 times actual earnings.
Netflix reported revenue growth of roughly 40% year over year in the first quarter, for $3.7 billion in sales. The company reported net income of $290 million, with earnings of $0.64 per diluted share. Obviously these are solid growth rates, but they're being countered by over $6 billion in debt, and poor free cash flow of negative $287 million. The reason I see the stock being able to hit $503 is momentum. Netflix's earnings have never justified its price performance. Valuations have also been high. Despite this, shareholders continue running the stock up on the speculation that user growth will eventually lead to large-scale profits. At the moment, I see little reason for that sentiment to change.
Let's say that Netflix does diluted earnings of $3.00 a share for the full year 2018. That's a pretty reasonable figure considering the first-quarter results, coupled with guidance for the second quarter.
CEO Reed Hastings himself was quoted the other day saying he sees Netflix doing $15 billion in revenues this year. The company's own guidance for the second quarter suggests earnings per share of $0.72. If the company follows that growth rate, $3.00 a share seems reasonable. At that point, Netflix would still be trading at over 167x earnings if it hits $503 a share. Is that expensive? Absolutely it is. But in Netflix terms, that's pretty cheap as the stock almost always trades at high multiple.
Because of this, I am absolutely convinced Netflix can hit $503. In the longer term, I see the company's ability to control the market narrowing.
The early bird does catch the worm. Can it keep it?
Netflix obviously has many advantages in its industry. For one, it was basically the first to truly capitalize on streaming media. Because of this, others within the space are just copycats playing catch up. It has an inherent edge.
That said, we must keep in mind that a lot of big money from very competent companies is getting invested in their own forms of streaming services. Disney's (DIS) position in Hulu, a position that might become even bigger if their talks with Twenty-First Century Fox (FOXA) succeed, is a serious threat to Netflix's long term dominance. Comcast (CMCSA) could create a problem of equal scale if they somehow win that bidding war.
Make no mistake, these firms are aware of the content war currently under way. They're all currently jockeying for position, as the streaming services with the best content will undoubtedly win the day. And let's not forget Amazon (AMZN) with their Prime membership, and general preference for attempting to dominate every facet of business known to man. They're still trailing Netflix, but a report from Reuters back in March shows their Prime subscription service is definitely gaining steam for its video content.
Moreover, they're putting around $4.5 billion into content. But I still view Hulu as the biggest threat long term in terms of market share to every player in the game.
As of May, the service had 20 million subscribers. That's one-third of what Netflix usually has, but the growth rate is strong. Hulu added 3 million new subscribers in the first quarter, outpacing Netflix's 2 million. I see no reason that this higher percentage growth won't continue. Hulu offers a more well rounded package with multiple add-ons. You can get live streaming TV. You can add Showtime and HBO as additional packages. It creates simplicity of experience that Netflix doesn't currently offer. If one of the big boys can consolidate ownership, they'll be able to really put some steam behind it.
If Disney succeeds in acquiring assets of Twenty-First Century Fox, they'll gain a heap of content, as well as a majority stake in Hulu. This will give them a big weapon against Netflix. The service is currently only in the U.S. and Japan, but I expect Disney would funnel it all into its own streaming plans and take this puppy worldwide. We've already seen in the past that shots have been fired to diminish the content available to Netflix. Disney announced last August that they were ending distribution agreements with Netflix, and launching their own streaming service. The acquisition of FOX assets and subsequent control of Hulu would certainly put that in motion. As Netflix loses all that content through time, they'll become increasingly more reliant on drawing in users with their own original content.
Netflix is planning to spend $8 billion on original content in 2018. Obviously a lot of their shows are great, but it's a much more costly process than licensing content from studios. If Netflix can no longer get their hands on that content, and is forced to compete with juggernauts like Disney directly in terms of making quality content, my bet is on Mickey Mouse.
The competition will also mean increasingly higher costs for Netflix as they try to create enough content to keep users engaged. Long term, this spells a problem with an unclear outcome.
I reiterate my thesis. Netflix can definitely hit $503 a share. Can it keep it?