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Netflix's (NFLX-Q) transition from an innovator in mail-order movie rentals to a frontrunner in online streaming has powered a surge of more than 1,000 percent in the company's stock price since 2006. But Morningstar believes Netflix's dominance in online streaming is in peril and the company's lofty stock price will be harder to maintain.
In a note to clients, Morningstar's Michael Corty says the combination of higher costs for content and growing competition in the online streaming space will be problematic for Netflix.
"Although it's much cheaper to deliver digital content than it is to ship physical DVDs, we expect acquiring digital content to be significantly more expensive than DVDs for Netflix," he says.
Corty says Netflix's profit margins will come under pressure from heightened competition; and at the same time licensing costs for higher quality content to expand the subscriber base is surging. Netflix said content acquisition costs increased to $613 million US from $192 million in the first quarter.
Competition in the DVD-rental space required a nationwide network of distribution centers which greatly increased barriers to entry. But entering the online space is much cheaper - and cable and satellite operators that produce their own content are not the only ones looking for market share.
"We view Amazon's (AMZN-Q) push beyond the Kindle as a sign that it intends to invest more in the streaming video business," Corty says. "Apple is the elephant in the room as it is the most successful hardware firm of the past 25 years and its recent growth has pushed its cash balance above $70 billion dollars (over 20 times Netflix sales)."
Corty has a $150 "fair value estimate" on Netflix stock. But he is not the only Netflix bear.
Robert M. Wasserman, Director of Research at Dawson James, recently initiated coverage on Netflix with a "sell" rating and a $181 price target-citing many of the same concerns.
"Acquiring streaming television content will likely continue to become more expensive for Netflix as the popularity of its service increases and further threatens traditional distribution channels such as broadcast and cable television," he said in a note to clients.
"Although Netflix has a strong history of consistent growth in both revenue and net income…[the stock] has become overvalued by as much as 50-60 percent compared to its peers."