Analyst: Here’s Why Netflix has Some Serious Growth Concerns

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

Netflix (NASDAQ:NFLX) delivered impressive subscriber growth and cost control to drive the Q4:12 beat.  Revenue was $945 million, compared with our estimate of $926 million, the consensus estimate of $934 million, and guidance of $919 – 943 million. The top-line beat was driven by better-than-expected subscriber numbers for all three operating segments. EPS was $0.13, compared with our estimate of $(0.10), the consensus estimate of $(0.13), and guidance of $(0.23) – 0.04. The EPS beat was driven primarily by lower-than-expected marketing spending, as well as the top-line beat.

Bullish Q1:13 domestic streaming subs guidance. Netflix (NASDAQ:NFLX) expects to add 1.35 – 2.05 million domestic streaming subs in Q1:13. The high-end of this range is equal to the net adds figure in Q4:12, while the midpoint of the range is in line with net adds from a year ago. Q1:13 guidance indicates that Netflix’s domestic business is not expected to slow significantly in the near-term, an important factor driving the strong after-market performance of Netflix shares.

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Raising our 2013 estimates to reflect lower marketing and content spending. Increasing our 2013 estimates for revenue to $4.38 billion from $4.03 billion and for EPS to $1.00 from $0.00 to reflect a stronger-than-expected Q4:12, better expense control, lower international losses and the assumption that Netflix will not expand further internationally in FY:13. Management  stated that the company will not launch in additional international markets in 1H:13…

Although Netflix has announced a number of new content deals in recent months, 2012 saw many subtractions from its streaming catalog. We expect higher costs to result in erosion of  the quality and quantity of Netflix’s content library over time, resulting in higher churn, and we expect domestic subscriber growth to slow or stall completely in the next few years.  We expect slowing growth to be evident later in 2013, with fewer net domestic subscribers added year-over-year.  We have modeled flat year-over-year domestic subscriber growth (net adds of 5 million), but think that growth may remain elusive.

Maintaining our UNDERPERFORM rating, but raising our 12-month price target to $55 from $45, based on better-than-expected cost control. We arrive at our revised price target through a sum-of-the-parts analysis that values domestic streaming at $28 per share, domestic DVD at $20 per share, and international streaming at $7 per share.

Michael Pachter is an analyst at Wedbush Securities.

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