Tuesday, March 15, 2011

Netflix (NASDAQ:NFLX): Enough demand for multiple players; raising estimates - upgrade to Buy - Goldman Sachs

Goldman Sachs is upgrading Netflix (NASDAQ:NFLX) to Buy from Neutral this morning with a $300 price target (prev. $210), implying 50% upside.

With shares down almost 20% in the last month and trading at a 1.0X 2012E PEG, the firm believes that NFLX shares overreacted to more visible signs of competition, while at the same time, sub momentum has been better than expected, Canada is near 10% penetration in 6 months, and Goldman's proprietary survey shows explosive growth for online video. As a result, they raise their 2015E paid sub estimate from 50 mn to 60 mn and their EBITDA margin from 16% to 20%. Our 2011- 2013 EPS estimates are now $4.56/$6.72/$8.72, up from $4.52/$6.21/$7.58.

Goldman upgrades Netflix to Buy as:

1) NFLX benefits from rapid growth of online video consumption, driven by the proliferation of connected devices - 27% of US consumers now stream TV shows/movies, up from 16% yoy according to GS Internet Usage Survey;

US consumers reported that the video sites they use most for watching video content online are Netflix (34% penetration), followed by YouTube (18%), iTunes (16%), and Amazon (13%).

2) Netflix now has sufficient scale to make it difficult for new entrants given low price points and expensive content costs; and

3) Competition to date has been underwhelming and Goldman believes that demand for streaming online content could be large enough for multiple players.

Goldman believes that Netflix could announce partnerships with broadband ISPs outside of North America, bundling the Netflix service with broadband access. These partnerships could speed the time to market entry, pull forward break-even points (as Netflix has to pay for content upfront in new geographies to attract subscribers), and share in the marketing costs with Netflix, potentially lifting margins in new markets.

Facebook – A potential “frenemy”
While consumers do not currently watch TV shows or movies on the Facebook platform, we could see Facebook evolving into an ecosystem where users could eventually download or consume different types of media, as they do with YouTube on Facebook.

Goldman notes, however, that Netflix could be among the players to also leverage the Facebook platform. In January 2011, Netflix pulled back from Facebook Connect as very few people had signed on for this service. According to Netflix’s blog1, the company will be “testing new concepts” on Facebook, including “getting our members connected to Facebook and in the coming months [the company will] add new ways for members to find interesting TV shows and movies to watch based on friends' recommendations.”

Catalysts include:

(1) International broadband ISP partnerships, allowing for sooner break-even points; (2) New market and product announcements; (3) Additional streaming content deals, including the possible renewal of the Starz Encore agreement; and (4) Earnings – Goldman expects 1Q sub growth and 2Q guidance to be strong

Notablecalls: Not making a call here on NFLX. Goldman's $300 price target is highest among Tier-1 firms. And they are talking about potential Facebook tie-up. So you know it's out there.

The market is a mess right now.

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