Netflix Drops on Valuation ‘Difficult to Justify’

Netflix Drops on Valuation ‘Difficult to Justify’

Netflix Inc. (NFLX), the second-biggest gainer in the Standard & Poor’s 500 Index this year, fell the most since October 2012 after Bank of America Corp. analysts called its valuation “difficult to justify.” The stock, which has more than tripled this year, dropped 9.2 percent to $322.52 at the close in New York, the biggest drop since Oct. 24, 2012. The shares reversed after jumping as high as $396.98 after hours yesterday following quarterly results that showed Netflix’s video-streaming service passed the premium cable-TV network HBO in U.S. paid subscribers.To warrant a stock of about $400, Netflix would need to get to 140 million subscribers globally, increase prices and improve margins, according to Nat Schindler and Justin Post, analysts at Bank of America. Chief Executive Officer Reed Hastings wrote yesterday of investor “euphoria,” while setting his sights on HBO’s global subscriber count.

“The real number we’re looking at is their 114 million, and we’re at 40 million,” Hastings said. “So we’ve got a ways to go.”

Netflix, the world’s largest online subscription-streaming service, said yesterday third-quarter profit increased fourfold to 52 cents a share, beating the 47-cent average of 27 analysts’ estimates. Subscriber growth at the streaming service was driven by original shows such as the prison dramedy “Orange Is the New Black.”

Including free trials, domestic users at Los Gatos, California-based Netflix rose 4.3 percent to 31.1 million from the second quarter, surpassing the 31 million average of eight estimates compiled by Bloomberg. Outside the U.S., the total reached 9.2 million.

Subscriber Story

“Netflix is a subscriber-driven story for investors,” said Paul Sweeney, an analyst with Bloomberg Industries. “The third-quarter results again demonstrate that story is fully intact.”

The results suggest Netflix’s Web-based service has growth potential beyond that of premium cable-TV networks. Hastings is offering a mix of original programs and unlimited viewing of movies and TV shows for $7.99 a month. He has begun talks to bring Netflix to cable-TV systems in the U.S., after reaching initial deals in Sweden and the U.K.

While the stock has been volatile, the company has increased its membership every year, he said.

“The progress we’ve made over the last 10 years is stunning,” Hastings said. “We want to make the next 10 years even more remarkable.”

Hastings estimates Netflix can reach 60 million to 90 million streaming members in the U.S. Over time, the majority of Netflix’s revenue will come from overseas, Hastings said.

Raising Cash

The company expects to double its spending on original content next year, Hastings said, and may raise money to pay for it.

“Since we are otherwise using domestic profits to fund international markets, we will raise capital as needed to fund the growth of original content,” Hastings wrote in a letter to shareholders. He declined to elaborate.

Netflix also said it’s changing the accounting for original shows that premiere on its service, which will result in costs being recorded sooner.

Third-quarter net income jumped to $31.8 million from $7.68 million, or 13 cents a share, a year earlier.

Sales increased 22 percent to $1.11 billion from $905.1 million a year ago, beating estimates of $1.1 billion.

Hastings has hooked viewers with original programs such as the Emmy-winning “House of Cards.” The company has also reached deals to get exclusive movies from Walt Disney Co. (DIS) and DreamWorks Animation SKG Inc. (DWA)

Owning Shows

Netflix is becoming “more comfortable” with the idea of owning shows in the future, rather than licensing them for set periods, Chief Content Officer Ted Sarandos said in a video interview after the results. Original programs build interest in the service and attract audiences over time, he said. The company is actively looking to produce original movies, he said.

While “Orange Is the New Black” spurred subscriber growth, a bigger percentage of Netflix viewing is generated by full-season reruns of shows such as “Breaking Bad,” “The Walking Dead” and “Pretty Little Liars,” Hastings wrote.

The company began service in the Netherlands during the quarter, bolstering international subscribers by 1.4 million. Netflix projected total worldwide users may reach 43.6 million in the fourth quarter, the midpoint of its forecast, including 10.5 million outside the U.S.

HBO Competition

In the U.S., paid subscribers totaled 29.9 million, Netflix said. That’s an increase from 28.6 million as of June 30, and puts Netflix ahead of Time Warner Inc. (TWX)’s HBO, which has about 28.7 million, according to researcher SNL Kagan.

Hastings is following the path of the older network, which he regards as his closest U.S. competitor. Thirty years ago, HBO aired its first original movie, a 1983 biopic of Canadian amputee and runner Terry Fox. Like HBO, Netflix has used original programming to build customer loyalty and to stand out from competitors such as Amazon.com Inc., the largest Web retailer, Hulu LLC and Redbox Instant by Verizon.

While the number of streaming subscribers is growing, the DVD business, which shrank 4.8 percent sequentially, “is declining more rapidly than we expected,” said Michael Pachter, an analyst with Wedbush Securities, who rates the stock underperform.

“The valuation makes no sense at all,” Pachter said.

To contact the reporter on this story: Cliff Edwards in San Francisco at cedwards28@bloomberg.net