UPDATE 2-Netflix jump raises concerns about valuation

Tue Apr 23, 2013 2:24pm EDT

* Forward price-earnings ratio 165 vs sector median 14.03

* Netflix is fourth-priciest stock in S&P 500 on P/E basis (Adds further context on valuation)

By Ryan Vlastelica

April 23 (Reuters) - Netflix investors may be cheering after a blowout quarter caused shares to surge on Tuesday, but the longer-term picture is cloudy as the stocks' valuation has reached a lofty level shared by few stocks.

The surge in Netflix Inc makes the stock the fourth-priciest in the S&P 500 on a valuation basis, an indication that shares may have become overextended. The stock jumped 25 percent to $217.50 on heavy volume, the biggest daily move since Jan. 24, taking it to levels last seen in September 2011.

The surge came a day after the company said it added more than 2 million U.S. subscribers last quarter, aided by the company's steps into original content, including the Kevin Spacey-starring political drama "House of Cards." It also posted profits that beat expectations.

"The stock is moving up a lot higher than we think it's worth," said Morningstar analyst Michael Corty, who believes a fair value for the stock is $110.

"I think the business model works," he said. "I just think the price it's trading at is assuming a lot of customer growth."

The stock is now trading at roughly 165 times estimated 2013 earnings per share, compared to the average for the sector of about 14. Only three other S&P stocks have loftier multiples: Vulcan Materials Co at 402; Prologis Inc at 210; and Amazon.com Inc at 182.

The current P/E ratio is more than three times the ratio the stock had when it was near its previous all-time highs in 2011.

Analysts at Dougherty & Company expressed caution about the share price, writing that "the company certainly has momentum, but with margins remaining under pressure...we can't make the valuation case to chase the stock here."

The firm affirmed its "neutral" rating, writing that "despite the first-quarter progress we're remaining on the sidelines until the path to double-digit operating margins become clearer."

Netflix is also trading well over its intrinsic value, or what Thomson Reuters StarMine believes a company's stock should trade at based on its most likely growth trajectory over the next decade or more (with steady growth assumed after that).

According to StarMine data, Netflix would have to drop 84 percent from current levels to reach its intrinsic value of $34.69.

The stock has more than doubled thus far in 2013, climbing 135 percent, and the big run-up has likely hit short sellers, who profit from betting that stocks will fall by borrowing and then selling shares, waiting for the price to drop so they can buy them at the lower price.

Tony Wible, an analyst with Janney Capital Markets, believes the long-term prospects for Netflix, with its position as the market leader, make it an attractive investment even at its current valuation. "I think a traditional valuation is a dangerous thing to use here," said Wible, who has a "buy" rating on Netflix shares and raised his price target on Tuesday to $250 from $190.

There are still many betting against the stock. The short interest position in Netflix for the most recent period, from the end of March, was 13.4 percent of shares outstanding, compared with less that 2 percent for blue chip companies such as Google Inc and IBM Corp, according to StarMine data.

Short interest in Netflix peaked at about 38 percent in April 2008.

Jeff Morris, who helps oversee $272 billion in assets as the head of U.S. equities at Standard Life Investments in Boston, said the stock was "seeing a bit of an extreme reaction" today, even though "it is putting up good subscriber growth and seems to be delivering on original content."

Nonetheless, analysts rushed to up their earnings forecasts for the stock, expecting the exclusive content to boost margins in coming quarters. They also lifted their targets for the stock price, which has now more than quadrupled in the past eight months, though it remains more than 35 percent under its all-time closing high, reached in July 2011.

At least eight brokerages, including JPMorgan, BMO Capital, Morgan Stanley, Barclays and Oppenheimer & Co, raised their price targets on the stock by as much as $75 to as much as $250.

"The solid performance in the March quarter combined with a better-than-expected outlook for the June quarter, aided by the upcoming release of 'Arrested Development: Season 4,' augurs well for the company in 2013 and beyond," BMO Capital Markets Corp analysts said.

"Arrested Development," a cult favorite that was dropped by network TV years ago, will premiere on Netflix on May 26 with the entire 15-episode season available to stream online.

The season, along with the show "House of Cards," is generating plenty of attention for Netflix at a time when more viewers are turning onto Internet video downloading.

"Four billion hours were streamed in the quarter - highlighting how the company's subscriber base is increasingly using Netflix for a growing share of their viewing trends," BMO said.

Netflix now has 29.2 million U.S. customers for its $8-a-month U.S. streaming service, the largest part of its business. (Additional reporting by Sayantani Ghosh in Bangalore; Editing by Dan Burns, Rodney Joyce, Lisa Von Ahn and Leslie Gevirtz)

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