Netflix’s Volatility Indicates the Rising Fear of Slowing Growth

Netflix’s (NASDAQ:NFLX) momentous fall in its stock price has created a very interesting situation. While competitors like Dish Network’s (NASDAQ:DISH) Blockbuster, Amazon (NASDAQ:AMZN) and Hulu are hoping to gain from the backlash among Netflix customers over splitting its DVD and streaming businesses, investors and traders are split on whether or not the market is over reacting — or if this move is justified on fundamentals. For some, it may signal a long-term buying opportunity given the amazing run the stock has had in recent years, and for others, it may signal a fundamental shift in the company’s growth outlook and expose flaws in the way the market previously valued the company.

If we assume that the current market price reflects long-term investor expectations, then the recent volatility suggests that investors are divided largely in two camps of bulls and bears and given the downward trend, the bears are winning.

Slower Subscriber Growth in the Future

Our $195 price estimate for Netflix is based on our expectation that over the course of next 7 years, Netflix will gain about 16 million domestic subscribers and 20 million international subscribers. This underlies our seemingly lofty valuation that implies nearly 50% upside to the market price.

The current market price indicates that our subscriber growth could be optimistic. For instance, in order to justify the current market price, Netflix’s domestic subscriber base will need to grow by only about 8 million over the course of next 7 years. Moreover, its international subscriber base needs to advance by less than 10 million over the same time frame. You can adjust these assumptions in our modifiable charts.

This represents a significant slowing in growth compared to what we have observed in the past couple of years and is well short of our current estimates. In other words, investors have dramatically changed the way they view Netflix and its growth outlook compared to before when our estimates appeared to massively undervalue the company’s growth prospects.

Rising Content Acquisition Costs a Key Concern

Given the recent events such as Netflix’s breakup with Starz, Dish Network launching its Blockbuster streaming service, Hulu crossing the 1 million member mark and Amazon beefing up its streaming content, one can argue that the battle to acquire content is going to be more intense and more costly in the future.

This increased competition among streaming services gives content owners better negotiating power, and as major broadcasters like CBS increasingly see retransmission and re-licensing deals as a way to reduce their dependence on fickle ad revenues, we expect content costs for Netflix could rise beyond our current estimates.

This is a key trend we are watching to monitor the cost structure of Netflix’s streaming only business going forward, as the company has clearly indicated that this is the future of the business. However, in light of the sell off that has wiped over 55% of value from its stock price since July, this could be a good opportunity for long term believers to take another look at the stock.

See our complete analysis for Netflix’s stock.