Here are the bull, bear cases for Netflix shares

Editor's note: The folllowing is a re-print of a posting by Finance Contributor Bidness Etc. You can access other Contributor viewpoints by clicking here.

Netflix, Inc. (NFLX) stock can still spring surprises on the Street. Just as it appeared moribund, it has put on 118.02% in its price, year-to-date (YTD), making it the year’s best performer on the S&P500 Index.

Here is what the Bears and the Bulls have been thinking about Netflix.

There is a great divergence between the most optimistic and most pessimistic opinions surrounding Netflix’ stock price. On one end of the scale is the $155 price target set by Pivotal Research Group LLC CEO, Jeffery Wlodarczak. At the other is the $40 target price set by Wedbush analyst, Michael Pachter.

The Main Difference Is The Perspective

The key point of difference between optimists and pessimists is to be found in their perspectives on valuation. Bulls argue that the company is in the growth stage of its life cycle. They say the stock should be valued on the business’ ability to grow its subscriber base. The bears argue that the company is now in the mature phase of the cycle. Therefore, future growth will be slower. For this reason the stock should be valued on the corporation’s earning potential.

What The Bears Say

The most bearish outlook on the sell-side is to be found at Wedbush. The firm believes content costs for the streamer will be a source of concern in the future. It has been critical of the over-optimism among investors, caught up by the growth in subscribers but overlooking risks associated with growing content costs. The organization’s revenue cost mostly includes the content cost. In two of the last three quarters, revenue growth was weak, compared to the rise in revenue costs. In each of the last three quarters, the sequential growth in revenues has been 5.30%, 6% and 4.50%. The growth of revenue costs has amounted to 6.83%, 6.65% and 6.82%, respectively.

The concerns don’t stop there. Management’s policy of using contribution margins to gauge the health of the business and amortizing less of what it spends, produces inflated earnings for the organization. Wedbush estimates the policy created a $796 million gap between reported income and GAAP-based income by the end of the first quarter.

Intensifying competition is another point of contention for skeptical analysts. Amazon.com, Inc.’s (AMZN) Prime service has a strong subscriber base. It is well-positioned to offer a standalone streaming service, separate from Prime. Should Amazon launch such a service, it will be in direct competition with Netflix for low-income consumers. For this grouping, a Netflix subscription is more affordable than the cost of Prime.

What The Bulls Say

On the more bullish side of the Street, analysts point to strong subscription growth. They argue that the domestic market is close to saturation point. In contrast, international potential is high. Plans to roll the service out to every available market by 2016 justifies the positive estimates, say the optimists.

This international expansion could help the company exert leverage on its licensing fees. It has global licenses for a large number of shows, adding new subscribers will mean revenues will increase, while costs will remain stable. Should content costs remain constant, a 1 million increase in subscribers will add $100 million to Netflix’ operating profits.

The move to more original content will help the company in two ways, say analysts. Firstly, with high quality original content, loyalty towards the service will increase. Secondly, the business will hold the global content rights. If it chooses not to license the rights for any of this content in a market, Netflix well retain a significant leverage in that territory. The streamer had 320 hours of original content at the end of last year. FBR Capital predicts this volume will double over the next two years.

In response to fears of rising global competition for Netflix, bullish analysts say the content offered by the webcaster makes it a must-have service. If the competition develop their own exclusive hit content, users may prefer to hold multiple subscriptions rather than replace Netflix with something else.

Overall Sell-Side View

Overall, the sell-side is bullish about Netflix stock. 22 out of 44 analysts listed on Bloomberg who cover the stock, rate it a Buy. 16 others mark it a Hold, while six rate it a Sell.

The consensus target price for the stock is $113.16, indicating a low return potential of 2%.

Our Take On The Stock

Bidness Etc continues to be bearish toward the stock. We believe there are significant risks associated with the bullish sell-side outlook. In a previous article we argued that although a rosy picture of Netflix makes its stock appear attractive, the risks should be weighed alongside the forecasts. Once again, we have to question the wisdom of basing bullish expectations on promises of far future performance that at this stage appear invalid.