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The Flipside to Netflix’s Great Latin America Adventure

6 Jul, 2011 By: Erik Gruenwedel

Despite expansion potentially yielding 3.8 million new subs and $360 million in additional revenue, some analysts are applying the brakes

Netflix’s ambitious expansions plans into Central and South America, the Caribbean and Mexico sent the Los Gatos, Calif.-based online disc rental pioneer’s stock soaring toward $300 a share — another all-time high.

Indeed, Netflix shares are trading 65% higher in 2011, and are nearly triple what they were worth a year ago.

But some analysts are questioning just how much higher Netflix shares can go, considering they’re trading at more than 40 times next year’s projected earnings and the company has said it expects operating losses from the expansion to reach $70 million in the second half of the year.

Eric Wold, research director with Merriman Capital in San Francisco, believes the market for broadband-enabled consumers in Latin America is about 40 million — a base he said could yield from 1.9 million to 3.8 million subscribers and $180 million to $360 million in annual revenues (based on an $8/monthly subscription price).

“We believe the projected (year-over-year) declines in operating margins for at least the next year could begin to negatively impact investor perceptions of growth trends and appropriate valuation multiples as they are reported,” Wold wrote in a July 6 note.

The analyst said he would not be surprised if Netflix management increased projected operating losses on the expansion going forward.

“While we believe this decision would be positive for Netflix's long-term growth prospects, it would likely cause a near-term shock to current earnings estimates and the valuation multiple,” he wrote.

Meanwhile, Wold suggests Netflix investors focus their attention (and money) toward Coinstar, or specifically, its Redbox kiosk rental platform.

He said Redbox remains a “wild card” in home entertainment due to its pending digital distribution strategy. Wold downgraded his rating on Netflix shares from “buy” to “neutral.”

Rick Munarriz with The Motley Fool investor website isn’t so sure Redbox is about to pull the trigger on a digital strategy, or if it even has one. He said speculated partnerships with Amazon and Walmart have gone nowhere — despite the prevalence of Redbox kiosks at Walmart stores.

“It's been promising a digital strategy since last summer, but it's been firing blanks,” Munarriz wrote in July 6 post.

The analyst agrees with Wold regarding Netflix reaching a ceiling on its stock valuation, adding that it won’t replicate what its done over in the second-half of the year.

“The next few quarters will be challenging, especially on the bottom line,” Munarriz wrote. “Netflix has already made it clear that overseas expansion won't come cheap, and that opens the door for sloppy profitability despite what should be solid top-line gains.”

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