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Dilantha De Silva
Dilantha De Silva
Articles (115)  | Author's Website |

Netflix Attracts a $500 Target Price From RBC Capital Markets

The company's investments to create high-quality content will be a catalyst for growth

June 10, 2020 | About:

Netflix Inc. (NASDAQ:NFLX) is among the very few stocks that have shaped the market performance since the fallout of the global financial crisis. The company changed its traditional business strategy on its head more than a decade ago by deciding to focus less on DVD rentals and more on enabling consumers to stream content online. This decision has proven to be very lucrative and the company is now the undisputed leader of a billion-dollar industry that is continuing to grow.

Shares of Netflix are up 30% this year as well, and the global lockdown played to the advantage of the company as consumers were left with few other entertainment options beyond subscribing to over-the-top streaming platforms like Netflix. In March, I discussed why David Einhorn (Trades, Portfolio) might continue to lose money with his short bet on the company. The latest analyst comments suggest the guru might continue losing money for even longer. In a notable move, RBC Capital Markets analyst Mark Mahaney reiterated his outperform rating for Netflix and assigned a target price of $500 on June 9.

Netflix is thwarting the competition in the U.S. for now

The short thesis for Netflix has been centered on two assumptions:

  1. Shares are overvalued from a traditional valuation perspective.
  2. The competition will eventually eat into company profits.

While the first concern remains valid more than ever, Netflix has successfully defended its position in domestic markets. Even on the back of the launch of highly anticipated services such as Disney+ (NYSE:DIS) and Apple TV+ (NASDAQ:AAPL), Netflix has been able to grow its penetration rate. RBC analysts found out that only 11% of existing Netflix subscribers canceled after signing up for Disney+ in the first quarter of the year. The unique nature of this industry makes it possible for many companies to coexist without hurting each other, and as the clear market leader, Netflix is unlikely to see a high number of cancelations resulting from the launch of new services.

International markets present a robust opportunity to grow

According to regulatory filings, the company is still generating the bulk of its revenue from the U.S. and Canada. However, Netflix has been increasingly focusing on other important regions such as Europe and the Asia-Pacific in the last couple of years by creating original content in local languages. This strategy has already seen massive success in Europe, which is evident from Netflix’s dominant market position.

Source: eMarketer.

The Asian region is proving to be particularly challenging for Netflix for several reasons:

  1. The internet penetration rate is still considerably low in comparison to developed nations.
  2. The competition from local players is intense in countries like India.
  3. Users prefer to watch pirated content as opposed to paying for a subscription.

Asia, by far, is the continent with the highest number of internet users with over 2.3 billion people accessing the internet every month. However, the penetration rate is still very low at just 55.1% in comparison to North America, Europe, the Middle East and Australia.

Source: Internet World Stats.

An encouraging sign, however, is the massive infrastructure projects being carried out by government authorities in Asia. Access to the internet has grown in the last few years and the penetration rate is likely to converge with that of North America in the next decade, which creates a strong platform for Netflix to win subscribers in this all-important region.

The company has introduced low-cost pricing plans to gain traction in emerging markets as well. For example, Netflix introduced a mobile-only plan for a discounted rate of just $3 per month in India. The company has spent billions of dollars to create content with a local flavor as well, but all these measures have done little to help Netflix gain market share. Competition from the local streaming giant Hotstar, which is a fully-owned subsidiary of The Walt Disney Co. (NYSE:DIS), has proven to be a difficult challenge to overcome. According to data from eMarketer, Netflix had a market share of just 3.5% in India in 2019, whereas Hotstar accounted for over 40% of the video streaming subscribers in the country.

Even though Netflix might never be able to control this South Asian market, the company is likely to gain some momentum in the coming years as rising income levels will lead to consumers subscribing for more than just one content streaming platform. Wall Street analysts also believe Netflix will be able to eventually grow its userbase by producing high-quality content that will not be available from its rivals.

The investments the company is making to create engaging content will be at the center of Netflix's growth for the foreseeable future. According to RBC analyst Mark Mahaney, the company is scheduled to release 130 original programs in 18 languages in the next 12 months and beyond, which would be a driver of new subscriptions. He wrote:

“We believe these investments should become the main driver of Netflix’s global penetration, creating a multiyear competitive advantage and potentially allowing the company to achieve higher penetration internationally than it has in the United States.”

The $500 target price indicates an upside of 15% from the market price of around $435 on June 10.

Takeaway

The short bet on Netflix is one of Einhorn's losing positions. The global lockdown that lasted nearly two months did not help the guru as the streaming giant reported higher-than-expected subscriber growth in the first quarter. This momentum is likely to continue for the remainder of the year as the superior content offered by Netflix usually helps the company retain the majority of consumers signing up for the service. The improving macroeconomic conditions in international markets is also a positive sign for the over-the-top streaming industry as it leads to an expansion in the addressable market. As the front runner of this industry, Netflix will naturally grow along with the industry, and shares will follow corporate earnings. This warrants a much higher market value per share. The positive sentiment toward tech companies will also play to Netflix's advantage in the coming years.

Disclosure: I do not own any stocks mentioned in this article.

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About the author:

Dilantha De Silva
I am an investment professional with 5-years of experience in financial markets. I specialize in U.S. equities and incorporate a top-down approach to identify developing macro-level trends and the companies that would benefit from such trends. I am a strong believer that the best investment opportunities could be found in under-covered equities.

I currently work with leading financial publications including Refinitiv, Seeking Alpha, ValueWalk, GuruFocus, and TradeGrill to produce investment-related content.

I'm a CFA level 2 candidate and an Associate Member of the Chartered Institute for Securities and Investment (CISI, UK). During my free time, I enjoy reading.

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