Netflix Swings Top Nasdaq 100 as Value Divides IcahnsCliff Edwards and Aubrey Pringle
Netflix Inc. Chief Executive Officer Reed Hastings warned in July that it takes “a strong stomach” to invest in the world’s largest video-subscription company. He wasn’t kidding.
The stock has posted the widest swings of any member of Nasdaq 100 Index in the past 30 days, according to data compiled by Bloomberg, evidence of a tussle over whether the video-streaming pioneer can turn its U.S. dominance of paid Internet TV into a worldwide phenomenon.
A more than tripling of the stock this year has left Netflix trading at 186 times profit, fueling debate and exposing differences that have even split families. Billionaire Carl Icahn, the largest individual holder, sold more than half his stake this month while son Brett, a fund manager at Icahn Enterprises, argued the stock is undervalued. The shares whipsawed after quarterly profit rose fourfold -- soaring after hours on Oct. 21, and slumping as much as 19 percent from there the next day.
“It’s hard not to like some of the things they’ve done, from massive subscriber growth, rising viewing hours, international growth and margin expansion,” said Tuna Amobi, an analyst with Standard & Poor’s in New York. “The question everyone struggles with is how long can they sustain this kind of astronomical growth?”
Netflix reached an all-time intraday high of $389.16 on Oct. 22, after third-quarter profit rose to 52 cents a share from 13 cents and subscriber growth beat estimates. Amobi, like 77-year-old Carl Icahn, used the milestone to reassess his view of the stock and cut his rating to sell from neutral that day.
The shares have since retreated 17 percent, trimming the gain for the year to 248 percent. Netflix rose 1.4 percent to $322.48 at the close today in New York.
At this level, Netflix is more expensive based on measured by trailing 12-month earnings than all but four stocks in the S&P 500. Amazon.com Inc., the online retailer, has the highest P/E at 1,300 times earnings.
Netflix’s 20-day historical volatility, measuring the magnitude of price swings, more than doubled to 69.2 on Oct. 31 from Aug. 19. It at the highest levels since May and almost five times that of the Nasdaq 100 equity benchmark. It’s the most volatile over 30 days, and the second-most volatile over 200 days, just behind Tesla Motors Inc., according to data compiled by Bloomberg.
The swings reflect the tug of war among investors and analysts. Supporters point to prospects for raising prices, little direct competition and signs the company’s international business may break even sooner than expected. Detractors cite a rising budget for films and TV shows, international losses and a current price that defies reason.
“We are choosing a strategy which has us put essentially all of our domestic profit into international expansion,” Hastings said on a July earnings call. “It definitely takes a strong stomach on the part of investors.”
Analysts’ price targets range from a high of $460 at JPMorgan Chase & Co. to a low of $122 at Albert Fried & Co. Of 38 analysts who follow Netflix, 8 suggest selling the stock, while 24 say hold and six recommend buying.
Laura Martin, a Needham & Co. analyst in Los Angeles, is among the bulls. Her sum-of-the-parts valuation produced a price target of $425. She said Netflix’s international business will break even sooner that she previously estimated, and that profit margins will continue to fatten.
Netflix will be a prime beneficiary as worldwide broadband penetration increases 30 percent to 90 percent annually through 2017, Martin wrote on Oct. 22.
The company’s continuing strong performance turned Tony Wible, an analyst with Janney Montgomery Scott in Philadelphia, from a longtime doubter into a believer. Wible, who argued for five years until January that the online movie service is too costly and risky, now has the second-highest price target at $450.
In the third quarter, Netflix passed Time Warner Inc.’s HBO in paid U.S. subscribers, reaching 31.1 million, and is poised to gain 6 million more worldwide annually, Wible said. That should be enough to fund its growth and make it harder with each passing quarter for competitors to keep up, he said.
“There’s significant and increasing cost pressure to being in this business and to the extent that you can keep rivals at bay, you get the ability to raise prices in the future,” Wible said. “Netflix is a longer-term bet on that.”
The difficulty in valuing Netflix stems in part from the fact that there is no other independent pure-play company available for comparison.
“Netflix is a very unique story, and I’ve seen analysts’ views all over the place,” Amobi said. “At the end of the day, any one of us can be wrong.”
Richard Tullo, an Albert Fried analyst in New York who’s had the equivalent of a sell rating on Netflix for the past year, predicts the stock will fall 62 percent in the next year.
“If I were Carl Icahn, I would battle with my son to sell the stock, too,” Tullo said in an interview. “Frankly, if we valued Netflix the way we value the rest of our universe we’d have to value it somewhere between $35 and $60.”
Tullo came to his $122 target by averaging an $80 price based on 2017 earnings estimates, a sum-of-the-parts valuation of Netflix’s domestic streaming, international streaming and DVD businesses, and a third component using Hulu LLC’s implied valuation on a per-subscriber basis.
Netflix’s international business had a nine-month loss of $217.1 million, the company said on Oct. 21, while the U.S. streaming business earned $449.1 million and the DVD-by-mail operation produced a profit of $328.9 million.
Investors focus too much on the buzz generated by Netflix investments in original programming and not enough on the fundamentals of the business, according to Michael Pachter, an analyst with Wedbush Securities Inc. in Los Angeles. The company will be hurt by rising program costs as film and TV studios demand ever more in contract renewals, he said.
“If you talk to HBO, they’d say 80 percent of the focus is on watching movies and 20 percent is original series,” said Pachter, who rates the stock underperform, the equivalent of a sell. “Even if Netflix does get it right every time with originals, what happens then?”
Hastings has weighed in on the volatility, too. In the company’s third-quarter letter to investors, he compared the recent rise with “euphoria” of momentum investors in 2003, when Netflix was the highest-performing Nasdaq-listed stock.
Netflix has no further comment, said Jonathan Friedland, a spokesman.
Hastings and most analysts agree on one thing: Success or failure will depend on getting and keeping subscribers. The shares have risen this year in part because two European cable operators agreed to add the application to their set-top boxes, while Netflix is in talks with at least five U.S. cable providers to do the same.
The Icahns settled their differences with what amounts to a side bet, made public in a regulatory filing last week. Brett Icahn, 34, and his fellow fund manager David Schechter rewrote their contracts so that the performance fee they receive from Carl Icahn will reflect gains or losses in the 2.99 million Netflix shares sold at his direction.
“We believe Netflix is one of the great consumer bargains of our time,” they said in a statement.