Verizon, on the other hand, is the country’s largest mobile carrier, a much bigger company with an enterprise value of $175.13 billion (against market cap of $127.05 billion). What makes it an even bigger threat to Netflix is that analysts expect it to grow 24% by December 2013. To make matters even more challenging for Netflix, Microsoft Corporation (NASDAQ:MSFT), which has been pushing hard to enter America’s living rooms, announced on Feb. 5 that it was partnering with Verizon for exclusive rights of offering the company’s Redbox Instant Video on its gaming consoles.
What goes in favor of Netflix, though, is that Redbox is still a beta service and Amazon owns only one-third of Netflix’s popular content. When I last checked in October 2012, Amazon required spending something like $1 billion-$2 billion to come at par and compete with Netflix.
There is room for all in this market, which is inherently ever-growing. In addition, the content licensing space is too fragmented and riddled with complex and conflicting rights and licensing. Netflix’s lack of a complete catalog of Hollywood movies is more or less compensated with other popular TV shows and videos.
Conclusion
Netflix’s most recent quarterly results reveal that it is basically a revenue play. If there are inferences to be drawn then, it is that the stock market has responded primarily to the increase in revenues and chosen to ignore the increase in content cost.
With time, content can only become more expensive and will be the biggest drain on profits. From 2008 to 2012, content acquisition and licensing costs have increased by as much as $1.4 billion, whereas gross margin has fallen from 33.3% to 27.3%. On the other hand, as compared to 2011, operating expenses in 2012 are up by 18.4%.
The potential for profit is there, but will take time for it to become a reality — investors need to watch incremental subscriber numbers because an increase in subscription rates is hardly likely. Only recently, Hastings burnt his fingers when he raised rates and was forced to back down after seeing a drop in subscriptions. Incremental increases in subscription rates, if at all, will take some time and are likely to be minimal.
Also of interest is the news that in December The Walt Disney Company (NYSE:DIS) entered into a multi-year licensing agreement granting Netflix exclusive rights for U.S. subscription television service for its first-run live-action and animation feature films.
Despite all this, valuation still remains a matter of concern. At $184.41, the stock is trading at 13.77 times book value and at an unbelievably high P/E ratio of 636.56. In my opinion the market is not considering factors like competition increasing in the future and the hurdles that Netflix will have to face while trying to increase revenues.
Despite analyst recommendations of holding the stock, if I was invested in Netflix I would get out at the first opportunity. At the same time, I would avoid being enamored by the dream run that the stock has had and stay away from it until it comes down and is realistically valued.
The article How High Can This Company Go? originally appeared on Fool.com and is written by Sujata Dutta.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
