Netflix – Time to Flee or Jump Onboard?

Posted by on Aug 13, 2010 | 2 comments

Netflix (Nasdaq: NFLX) hit an all-time high on Thursday, up $6.58 to close at $133.05. Though shares slipped less than 1% this morning, Netflix is up 12.45% so far this week, and up an incredible 29.74% in nine trading days of August.

A look at the chart reveals a moon-shot ascent since late 2008 when Netflix traded under $20 briefly in November of that year.

With a stock trading at 35.20 times next year’s earnings, it’s getting pricey, even with a PEG ratio that still calculates to approximately 1.65. Investors can be comforted with a PEG well under 2.00, but not as the result of earnings growth expectations so high.

In addition to a rich P/E, Netflix trades at more than 70 times trailing free cash flow. One value investor, Adib Motiwala, calculated the growth rate of free cash flow required to “justify current valuations.” Motiwala’s article regarding Netflix is worth reading.

Motiwala stated that under his assumptions, free cash flow will need to grow at approximately 40% for 10 years to justify the stock’s price. That’s a lot of power growth through the rest of this decade.

The latest crazy buying in the stock came on Tuesday, following Netflix’s announcement that it made a content license agreement with Epix, a premium TV network, which will allow Netflix customers to view streaming movies downloaded from the Internet.

Netflix agreed to pay a total of $1 billion in five annual installments for the license.

That’s great. Every one knows retail film sales over the Internet are where the action is. The company appears to have scored a coup here.

But analysts Brian Fitzgerald and Brian Pits for UBS see potential problems on the horizon with the Epix deal that investors should pay close attention to.

In their note to investors, they state that the Epix deal “appears expensive.” At $1 billion to be paid in annual installments during the next five years, it’s a relatively very expensive TV output deal. A price tag of $200 to $300 million would be a more appropriate price to pay.

The deal doesn’t include TV rights.

There’s a 90-day window between the release of a movie and the license to sell it, which the UBS analysts state “reduces the value prop” for Netflix.

Some new releases are excluded from the deal, too. Large DreamWorks titles aren’t include, because of the separate deal made between DreamWorks and HBO.

The Epix deal could put a lot of pressure on gross margin, stated the two UBS analysts. The Epix deal suggests to them that Netflix won’t renew its deal with Starz (which costs Netflix very little). But instead, Netflix will pay $200 million in annual renewals, “which would significantly cap/pressure gross margin in 2011+,” the analysts noted.

Additionally, what if something out of the blue comes out to spoil Netflix’s plans? The stock will crash under the intense weight of disappointment and revised earnings forecasts.

Today’s rich valuations will also induce selling at some point, possibly taking the shares much lower as momentum traders and Johnny-come-lately investors panic out of the stock. The cooling down of the “animal spirits” can be a dangerous environment, especially when it involves a stock that’s already priced-in what investors may perceive as Netflix’s catbird position in the sector.

Finally, there were too many call option positions taken on Tuesday, bring the total of underlying stock share-count to more than six million shares going long in the option market. Too many traders have been on one side of this trade lately—which is not a good sign in the short term.

Given the perfection Netflix must live up to, the risk of problems Netflix could encounter, as well as inevitable profit-taking in the stock after a large run up, it might be time to take some money off the table—like right now.

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BeaconEquity.com is committed to producing the highest-quality insight and analysis of small cap stocks, emerging technology stocks, hot penny stocks and helping investors make informed decisions. Our focus is primarily on the underserved OTC stocks market, or “penny stock” market, which has traditionally been shunned by Wall Street. We have particular expertise with renewable energy stocks, biotech stocks, oil stocks, green energy stocks and internet stocks. There are many hot penny stock opportunities present in the OTC market everyday and we seek to exploit these hot stock gains for our members before the average daytrader is aware of them.

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While all information is believed to be reliable, it is not guaranteed by us to be accurate. Individuals should assume that all information contained in our newsletter is not trustworthy unless verified by their own independent research. Also, because events and circumstances frequently do not occur as expected, there will likely be differences between the any predictions and actual results. Always consult a real licensed investment professional before making any investment decision. Be extremely careful, investing in securities carries a high degree of risk; you may likely lose some or all of the investment.

About BeaconEquity.com

BeaconEquity.com is committed to producing the highest-quality insight and analysis of small-cap stocks, emerging technology stocks, hot penny stocks and helping investors make informed decisions. Our focus is primarily OTC stocks in the stock market today, which have traditionally been shunned by Wall Street. We have particular expertise with renewable energy stocks, biotech stocks, oil stocks, green energy stocks and internet stocks. There are many hot penny stock opportunities present in the OTC market everyday and we seek to exploit these hot stock gains for our members before the average daytrader is aware of them.

Beacon Equity Group Disclaimer

This newsletter is a paid advertisement and is neither an offer nor recommendation to buy or sell any security. We hold no investment licenses and are thus neither licensed nor qualified to provide investment advice. The content in this report or email is not provided to any individual with a view toward their individual circumstances. Beaconequity.com is a wholly-owned subsidiary of BlueWave Advisors.

While all information is believed to be reliable, it is not guaranteed by us to be accurate. Individuals should assume that all information contained in our newsletter is not trustworthy unless verified by their own independent research. Also, because events and circumstances frequently do not occur as expected, there will likely be differences between the any predictions and actual results. Always consult a real licensed investment professional before making any investment decision. Be extremely careful, investing in securities carries a high degree of risk; you may likely lose some or all of the investment.

  • http://www.stock-trading-program.com Stock Advice

    Sounds like a great newsletter. No matter who you are, you should always give these sort of things a try. You never know where million dollar advice will come from.

  • http://fadi.el-eter.com Fadi El-Eter

    I have actually written about this today, this is a BAD stock that should be avoided at any cost, and no I’m not shorting it. Netflix cannot sustain the growth rate and they can never meet the high expectations from the stakeholders, not to mention, also, that there is currently no real competitor, which will not be the case forever.

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