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When Business Insider asked David Einhorn for his most important chart, lesson, or idea of 2015, he sent back a chart of Netflix stock. It showed the stock price rising even as earnings estimates for 2015, 2016, and 2017 have fallen.
At the start of 2015, Netflix announced plans to expand to 200 countries by 2017, which prompted Einhorn, the head of Greenlight Capital, to write investors earlier this year that "NFLX changed its story and pushed its promises into the distant future." Is Einhorn right to be so bearish on Netflix, or should investors ignore his assessment?
All about time horizonGoing from 50 countries to the entire world in just three years isn't cheap. Not only does Netflix have to spend heavily to get its infrastructure in place, but also the content rights for specific regions or global rights often come with high price tags.
As such, Netflix's rapid expansion plans necessitate a dramatic increase in spending. To that end, Netflix already plans to increase its content budget about 50% in 2016, with nearly 40% of the $5 billion it's earmarked set aside for international rights. But since Netflix is expanding so rapidly, it's not able to see a return on its investment before it starts going after other markets.That results in a decline in profit estimates, as Einhorn accurately points out.
But Einhorn is stuck thinking of Netflix as a stock, and not the actual business that it is. Einhorn wrote in his second-quarter letter to Greenlight Capital shareholders: "[Netflix] transitioned from a company judged by how much it earns into a company judged by how much it spends. Whether the spending proves successful won't be known during the investment horizon of most NFLX shareholders."
He's right that most shareholders won't hold to stock long enough to find out if Netflix's spending increases will pan out and turn into global dominance. But the business will certainly still be there five years or a decade from now, and long-term, Foolish investors will find out if Netflix stock is actually worth the huge premium investors are currently paying for it.
Amazon.com is a prime example of a stock that trades for huge multiples of its current earnings and is spending heavily to grow its fulfillment network and Prime subscriptions. Nonetheless, the company's stock continues to climb as the earnings potential continually improves. The story is very similar with Netflix.
The long-term story for NetflixWhy aren't more investors concerned with Netflix's declining earnings estimates for the next few years? Because the long-term investment thesis for Netflix is stronger than ever.
As noted, Netflix is expanding rapidly to become available all over the world. What's more, it's now producing its own originals and acquiring global rights for most of them. And while many people don't join Netflix just for the original content, the originals do a good job of keeping them subscribed once they do join.
Additionally, the strength of Netflix can be seen in its ability to increase its pricing. U.S. subscribers have experienced two price increases in the past two years. And while domestic subscriber growth has slowed somewhat, it appears more a product of saturation than churn. Over 50% of Americans have watched Netflix in the past year -- that's more than the percentage of people that watched YouTube. Netflix has also successfully raised its prices in select international markets such as the UK.
Operationally, Netflix is performing at its peak even as more streaming services come online and compete with it. So while we don't know for certain what effect all of its current and planned spending will have on its bottom line, the outlook is very strong right now.
The article Is David Einhorn Right About Netflix? originally appeared on Fool.com.
Adam Levy owns shares of Amazon.com. The Motley Fool owns shares of and recommends Amazon.com and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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