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Netflix Has Moved Too Far Too Fast: BAML

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Netflix, Inc. (NASDAQ:NFLX) has rallied  far off too fast since reporting Q4 earnings results on January 23. The company is up 23 percent following its announcement of earnings that blew out estimates by analysts, sending the stock to the roof at Nasdaq stock exchange. However, according to analysts, Netflix could be bound to plunge as its rapid rally could prove unsustainable.

Netflix Has Moved Too Far Too Fast: BAML

The internet-based video streaming company trades at 605.07x trailing intra-day P/E compared to Time Warner Inc. (NYSE:TWX)’s 16.94x, the owner of HBO. Netflix, Inc. (NASDAQ:NFLX) has a profit margin of 0.48 percent and an operating margin pegged at 1.39 percent. Despite beating  estimates made by analysts, the company’s most recent quarter revenues grew by only 8 percent compared to it’s closest rival Amazon.com, Inc. (NASDAQ:AMZN) whose profits were up 22 percent year-over-year for the most recent quarter.

In a report published Monday, February 11, Bank of America Merrill Lynch (BAML) analysts reiterated Netflix at Underperform with a price objective of $96, about 46 percent discount on Monday’s close ($177.89). The analysts pointed the company’s weak fundamentals as a likely headwind for a sustainable rally, especially at the current rate. Netflix opened on Tuesday, Feb 12, at $180.95.

In the report, the analysts wrote, “Since reporting Q4 results on Jan. 23d, Netflix stock has rallied 73%. Although results beat expectations, we believe the stock has moved too far too fast given limited fundamental change and our continued belief that: [First], the total domestic sub base will top at ~35mn; and [Second], pricing power is not as strong as some suggest when the company is churning 5-6% of its sub base each month. We are reiterating our Underperform rating and $96 PO based on an SOP analysis”.

The analysts’ analyzed the Bull and Bear scenarios of the stock to back their argument as well incorporating price increments. According to the report, the analysts believe that the Bulls are betting on price increase coupled with availability of cheaper tablets in the market.

Key bull arguments include:

1) Cheaper tablets have changed the game and subs are going much higher as a result;

2) Netflix, Inc. (NASDAQ:NFLX) can increase prices because they are cheaper than HBO and have a relatively deeper library; and

3) Original content will be a game changer and help drive sub beats.

The analysts estimates for the bull scenario indicate $10.25 in EPS, which assumes 45 million subs at 35% contribution margin. This also would mean for each $1/month price increase, EPS would increase $5.48. The analysts believe this to be very unlikely.

The analysts perceive that investors’ expectation is for Netflix, Inc. (NASDAQ:NFLX) to reach 45mn subs in both the domestic & Intl streaming segments (90 millon total). They have an estimated average selling price of $8.99 month, or an increase of $1/month. However, this they believe that, at a price of $180 per share, bear scenario looks the most likely.

In the report, the analysts wrote “exclusive content is going to add to costs in 2013 and beyond, and sub growth of 5.5 million for 2012 is better than expected but still 23% below management’s 7.0 million guidance and hints that Netflix, Inc. (NASDAQ:NFLX) is past its second inflection point on the S-curve of adoption. [Additionally] competition, although weak now, is only getting stronger, and [there is also]  unproven performance of recently signed expensive long-term content agreements”.

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