Netflix Is Overvalued, Bernstein Analysts Say

Netflix’s current stock price reflects “unrealistic expectations” for growth, a pair of Bernstein Research analysts wrote in downgrading their ratings on the company to “underperform.”

By 2020, Netflix in the U.S. will reach a “steady state” of 43 million users with streaming contribution margins to expand to 32%, Bernstein analysts Carlos Kirjner and Ram Parameswaran wrote. But they said the current stock price reflects an expectation of at least 50 million domestic streaming subscribers with contribution margins closer to 40%.

“[T]he stock’s current valuation reflects unrealistic expectations across all major economic and strategic levers of the business,” Kirjner and Parameswaran wrote.

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The duo downgraded the stock to “underperform” (from “market perform” previously) with a 12-month price target of $180 per share. That’s 17% less than Netflix’s closing price Monday, at $215.60 per share.

Netflix has packed on net subscribers to its Internet-video business at a rapid clip. Company had 36.3 million total at the end of March, including 29.17 million U.S. subscribers — meaning it’s now bigger than HBO in terms of users.

Netflix’s stock has historically been volatile, and will face “material volatility” over the next two quarters as investors trade on net additions, Bernstein analysts said. The company’s decelerating growth will become clear between the fourth quarter of 2013 and second quarter of 2014, they wrote.

For Netflix to hit 50 million U.S. streaming subscribers in steady state would require the company either to serve about 90% of the addressable market in any given year or operate with monthly churn of less than 1.5% a month, according to the Wall Street analysts’ calculations. “We are not aware of any at-scale subscription service without contracts or material customer investment in setup and installation with such low churn and hence find the 50 million subscriber scenario highly unlikely,” they said.

In addition, Netflix is facing mounting competition from Amazon.com’s Prime Instant Video, as well as other online video services including Hulu Plus and YouTube. Furthermore, the analysts expect cable and satellite providers to increase and improve the quality and selection of their TV Everywhere and VOD services.

Even the 43 million U.S. subscriber forecast would be 66% of Netflix’s addressable market, and more than double HBO’s penetration of its domestic addressable market. Netflix’s $8 monthly price point beats HBO’s average retail price of $12 to $14 per month.

The analysts noted that they value Netflix’s business using a sum-of-the-parts model, with domestic streaming business at $83 per share, the DVD business at $18 per share, Latin America at $17 per share, Canada at $10 per share and Western Europe at $48 per share (on the assumption Netflix will expand to all major Euro countries).

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