Should Netflix Spin Off Its International Operations?
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It may be time for Netflix (NAS: NFLX) to begin winning again.
Battle Road Research upgraded the stock late yesterday, boosting its guidance from "sell" to "hold." Moving up to a neutral position in and of itself may not seem like a very flattering upgrade, but the leading video service can use any signs of encouragement it can get these days, with the stock trading near last month's two-year low. You have to go all the way back to January 2010 to find the last time the once highflying stock has been consistently trading at these uninspiring levels.
Patting itself on the back, Battle Road points out how the stock has already shed more than half of its value since the firm downgraded the stock this past October. Then again, getting the downturn right is probably just as good a reason as any to pay attention to its reasons for the upgrade.
King of the streaming hill
As bulls often argue, there's a disconnect between where the stock is and where Netflix's popularity stands with consumers. Yes, last year's price increase and Qwikster fiasco were rough, but video buffs have learned to forgive and renew.
There are now more than 30 million Netflix subscribers, with 27.6 million of those aboard as streaming customers worldwide. Battle Road argues that Netflix remains a "disruptive force," and rightfully so.
There is no other premium streaming service that even comes close to serving the billion hours of video that Netflix is currently cranking out on a monthly basis. Amazon.com (NAS: AMZN) is beefing up its digital catalog. Coinstar's (NAS: CSTR) Redbox is teaming up with Verizon (NYS: VZ) for what should be an intriguing platform later this year. Cable and satellite television providers are bending over backwards to keep churn low by throwing digital smorgasbords at its well-paying accounts. And none of it has slowed Netflix's ability to attract and retain its growing army of TV fans. Netflix is still on top, and the gap seems to grow with every passing quarter.
Disparity on Wall Street translates into opportunity for investors
International losses have been weighing on Netflix's bottom line, and Battle Road sees that trend continuing for several more quarters.
Analysts are all over the map with how things will play out on Netflix's bottom line. The 30 major firms modeling the company's profitability see as little as a deficit of $0.39 a share to as much as a profit of $0.58 a share. Battle Road is perched on the higher end of that range, looking for net income of $0.32, well ahead of the $0.08 market average.
Next year isn't getting any easier to nail down. All 30 pros see a solid profit, but those targets go from $0.16 all the way up to $3.93. In other words, depending on the analyst you trust, Netflix is trading between 14 and 350 times earnings.
The wide range stems largely from the unknowns of international expansion. Netflix disappointed investors in its latest quarterly report when it warned that expanding into a new market -- later revealed as Scandinavia -- would result in an overall deficit during this year's final quarter.
Investors don't like uncertainty, especially when the company has made it clear that it will continue to engage in profit-slurping overseas expansion in the future.
Citigroup analyst Mark Mahaney issued a bullish note on Netflix earlier this summer, pointing out that Netflix was trading for just 12 times the profitability of its domestic operations. The stock was sharply higher at the time. Those same assumptions would now price Netflix's stock at just nine times its stateside business.
Weaknesses can become strengths
Travelzoo (NAS: TZOO) has been there. The travel-deals publisher was losing money overseas, and since Uncle Sam doesn't let a company use international losses to offset taxable profits closer to home, it was paying an effective tax rate of more than 100% for a couple of quarters.
Netflix obviously isn't there yet, but how many people know that Netflix's effective tax rate through the first half of this year was a whopping 56.5%? And you're complaining about your tax bill?
What will happen to Netflix's bottom line the moment that either its international operations are profitable or it decides to either suspend or spin off its overseas endeavors?
Wait. What? Spin off its international business? The last time Netflix attempted to break itself up into two, we got the Qwikster disaster. However, this would be an entirely different situation. Despite the losses, there's clearly a value greater than zero for Netflix's international segment.
Netflix has just 3.6 million international subscribers, generating revenue of $108 million and a contribution loss of $192 million through the first half of 2012. However, growth investors would still appreciate how far this segment has come in just two years. More importantly, a split would result in a ridiculously attractive earnings multiple for its flagship business.
Will this happen? Probably not. Netflix may be too proud. It may not want to lose the top-line sizzle that comes with treating the world like a Risk game board. Revenue growth would be weak, having grown just 7% domestically over the past year.
However, the lower Netflix's stock gets, the clearer the decision will be. Netflix is too cheap and misunderstood for this not to happen. The Fool's new premium research report on Netflix details the opportunities and challenges in store for its shareholders and is a must-have value for any investor seriously thinking about buying this streaming giant. The report includes a full year of updates, so time's ticking. Check it out now.
The article Should Netflix Spin Off Its International Operations? originally appeared on Fool.com.The Motley Fool owns shares of Netflix, Apple, and Amazon.com.Motley Fool newsletter serviceshave recommended buying shares of Netflix, Apple, Amazon.com, Travelzoo, and Coinstar, creating a bull call spread position in Apple, and creating a bear put ladder position in Netflix. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.Longtime Fool contributorRick Munarrizhas been a Netflix subscriber and shareholder since 2002. He also owns shares of Travelzoo and is part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Motley Fool has adisclosure policy.