How Netflix, Inc. Could Become the Second-Biggest Media Company
Shares of Netflix, Inc. (NASDAQ:NFLX) have been on fire, up a robust 13.2% to start 2018. For perspective, that’s an average gain of about 1.5% daily for the streaming giant.
It far outpaces the rest of FANG, with Amazon.com, Inc. (NASDAQ:AMZN) up about 9%, while Facebook, Inc. (NASDAQ:FB) and Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) are up “just” 5.5% and 6.4%, respectively.
How much higher can NFLX stock go? Barclays analyst Kannan Venkateshwar initiated NFLX stock with a “Buy” rating and $245 price target. From current levels, that implies about 13% more upside, although NFLX has been rallying since his call.
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Venkateshwar doesn’t just say FANG is the best, and you should buy. He argues that there’s a very low chance of Netflix missing consensus subscriber growth targets in the short term. Further, if the company is able to grow its subscriber count at a faster rate than its content costs, it could become “one of the most successful media companies.”
But he didn’t stop there, saying, “in the next 3-5 years Netflix is likely to become the second biggest media company by revenue” behind Walt Disney Co (NYSE:DIS) when you exclude theme parks and studio.
Disney taking Twenty-First Century Fox Inc (NASDAQ:FOX, NASDAQ:FOXA) out of the mix via an acquisition makes the feat easier. It’s also not as impressive when you subtract Disney’s studio revenue. But still, this would be a huge feat for Netflix.
The Future for Netflix
Netflix really has built the future of content consumption. It’s why Venkateshwar is so bullish on the long term. The problem, in my view anyway, is content. Disney is pulling out and going at streaming on its own. From a competition standpoint for Netflix, Disney doesn’t worry me. But content costs could be an issue.
Netflix plans to spend about $8 billion on content this year. That’s a massive amount of money for a company with an $85-billion market cap. In 2017, Netflix raised prices for domestic subscribers by a dollar per month. That translates to a roughly $180-million quarterly increase.
While the free cash flow expense is heavy and the margins will thin as a result of higher costs, investors are hoping it will be worth it. The company generates about $600 million per month from its domestic subscribers.
Raising prices was a great move, as it will ease free cash flow concerns and help pay for some its new content plans. Now at just $9.99 per month, I think Netflix has flexibility up to $12/month. Will it go there? Over time, I’m sure it will, but I wouldn’t expect it in the short term.
Netflix has a good thing going for it right now. It raised prices but didn’t see a backlash. Wall Street is giving it a pass on big expenses, knowing it needs a strong catalog of content in order to fight off competition and continue adding subscribers.
It’s easy to get hung up on the stock over the short term because of its valuation. But when thinking long term, it’s hard to imagine a world where it’s not Netflix-and-chill.
Trading NFLX Stock
In a way, NFLX stock is reminiscent of Amazon stock back in the day. Amazon used free cash flow to grow all sorts of business segments. It took market share and is now the king of retail. Netflix is doing the same thing with content.
It’s an easy-to-access content portal for customers who can get (almost) whatever they want, when they want it. More content makes it more attractive, and free cash flow can help pay for it. While the valuation for Netflix stock is high (like Amazon), investors justify it because Netflix is the industry’s largest disruptor. The blueprint is set.
So how do we trade NFLX stock? After tagging a new high near $205 in mid-October, Netflix stock retreated. After trending lower toward year-end, shares suddenly broke out over $195. Netflix stock promptly rallied around $25 per share from there, and now we’re in wait-and-see mode.
Netflix stock is overbought and has run too far, too fast. I don’t like to chase into earnings, which Netflix will report on Jan. 22. I’m looking for a pullback to $205 or so before considering a long position.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell held a long position in DIS.
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