Daily Ticker

Netflix Could Be the Next Big TV Network

Daily Ticker

Wall Street is betting heavily that Netflix (NFLX) will soon be the next big TV network – and maybe already is.

In the past few months, the streaming-video service surpassed Time Warner Inc.’s (TWX) HBO in paid U.S. subscribers, with 31 million viewers agreeing to pay Netflix $7.99 a month for unlimited access to movies and TV series – including its own hit original programs “Orange Is the New Black” and “House of Cards.” The latter, of course, became the first series to win an Emmy without ever having aired on broadcast or cable TV.

Related: Worried About Netflix's Sky High Stock Price? So Is Reed Hastings

In reporting a quadrupling of profits late Monday, Netflix said its users streamed five billion hours of programming in the third quarter, up 25% from the first three months of the year. Only the Big Four broadcast networks – ABC, CBS, Fox and NBC – serve up more program hours than Netflix.

Through its sophisticated personalization software, Netflix serves up suggested shows and movies that it anticipates a user might like, increasing its share of their entertainment-consumption time. The company is now trying to become a feature on cable and satellite systems’ set-top boxes alongside traditional networks, further blurring the line between direct-subscription serves and “bundled” monthly programming plans.

The company, which began as a DVD-rental-by-mail novelty service, is now among the largest buyers and developers of films and TV shows in media. It spends some $2 billion a year on video content. While most of it is created and released by other media outlets – such as full seasons of “Scandal” and “Breaking Bad” - Netflix is aggressively increasing its commitment to producing its own exclusive series. It will soon introduce second seasons of “House of Cards” and “Lilyhammer,” as well as “Derek” and “Hemlock Grove.” The company says it will double its spending on original programming in the next year.

Related: Netflix Owns Nothing, Is Poised for Short-Term Drop: Pachter

Excitement over Netflix’s potential to grow into a near-universal, all-you-can-view service has dazzled investors and made Netflix shares among the hottest in the market.

It’s hard to dispute, in fact, that Netflix shares are expensive. The more interesting questions are whether the shares are wildly overvalued by a herd of deluded momentum investors, or properly pricey to account for the company’s stellar growth record and vast opportunities to grab an enormous share of the paid media economy.

And what, if anything, should Netflix and CEO Reed Hastings consider doing to take advantage of its towering valuation?

With a $23 billion market value after the stock’s 300% surge this year to $381 following strong quarterly results, the streaming-video leader is valued at $550 per subscriber, six-times this year’s revenue and more than 100-times next year’s forecast earnings – all many times the multiples of peer companies and the broad market. Even Hastings granted that the stock’s rocking performance seems driven in part by investor “euphoria.”

The Daily Ticker's Henry Blodget is inclined to give the company, and the stock, the benefit of the doubt. “You don’t know whether it’s overvalued – nobody does,” he said in the above video. "Most of the people who are ridiculing it right here at $400 a share were ridiculing it at $70."

Related: How Amazon's Mayday Could Change Your World and Disrupt Apple

“What they have done is replicate the HBO strategy of, replicate other people’s stuff, add on the cream of your own stuff. They are the future. TV is going to route on all these different ways” – any place, any time, on any device, says Blodget.

Netflix is ingeniously piggybacking on the expensive high-speed broadband infrastructure built by cable and telecom giants in recent years. By one Barclays Capital estimate, Netflix is responsible for about a third of all “downstream” Internet traffic.

The company is investing heavily to acquire and create content and to market the brand worldwide, sacrificing near-term profits to establish itself as the global leader in one-stop entertainment.

Blodget compares Netflix to Amazon.com (AMZN), which has always forgone the chance to earn lush profits in order to plow money back into expanding the brand into new products and platforms. Wall Street has rewarded Amazon nicely for this strategy, recognizing perhaps that it has a huge opportunity to become ever-more indispensable to consumers and could choose to reap higher earnings any time it so chooses in the future.

This may be true, but at some price a stock’s valuation and the expectations of Wall Street will be too high, and any slight stumble in subscriber growth or a dud original series could trigger a nasty reversal in the stock.

At some point, Netflix might find that its appetite for rapid growth and ever-more-compelling programming makes acquiring a big content producer important to ensure access to exclusive, original shows and films. As such networks like HBO and AMC Networks (AMCX) have shown, the continuing loyalty of viewers requires a steady succession of addictive, resonant hit series such as “Game of Thrones” and “Mad Men.”

Such a company as Lions Gate Entertainment (LGF), as an example, is a scrappy maker of series and movies with a knack for buzz-worthy hits. With a market value of about one-quarter that of Netflix, such a hypothetical deal would certainly seem doable.

Then again, Netflix might be fine shopping for great entertainment on the open market for a long time to come. This still leaves open the question of whether Netflix ought to take advantage of its high stock price by issuing more shares to a voracious, enraptured investing crowd. Some on Wall Street are suggesting just that, selling a couple of billion dollars worth of stock to build its cash war chest, to be used in building up its content library and marketing campaigns to quicken subscriber growth.

Netflix executives were asked on the earnings conference call whether the company might look to raise more capital given how high the stock is and how cheap it is to sell debt currently. CFO David Wells said, “we don't feel capital-constrained right now in terms of our pace of expansion. If we did, we would go out and tap the market.”

Of course, it might be tricky for a CEO to get on the road to sell his company’s shares to the public after he suggested the stock has been levitated, in part, by “euphoria.”

Related: The Business of "Breaking Bad" is Good; Netflix Not So Bad Either

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