Gene Marcial's Stock Picks June 19, 2009, 5:16PM EST

Marcial: Why Pros Are Watching Netflix

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BW's Gene Marcial

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The Xbox factor

Netflix has teamed up with consumer electronic companies to provide a range of devices that can instantly stream films, including television shows, to Netflix members' TVs and other devices. In the case of actual DVDs, Netflix offers one-day delivery to most subscribers from about 60 distribution centers in the country.

"We expect additional consumer electronics manufacturers to embed the Netflix streaming software," says Martin Pyykkonen , an analyst at Wunderlich Securities, who rates the stock a buy. So far, the streaming software is embedded in LG and Samsung flat-panel TVs, Roku and TiVo players, Apple Macs and Apple TV, and the Microsoft Xbox 360 video game console.

Redbox could become a "meaningful competitor," concedes Quarles of Thomas Weisel, but Netflix has strong options and is well-prepared to fight back, including expanding its arrangement with Microsoft (MSFT), which has added Netflix to its list of content providers in the Windows Media Center. Since November, Netflix has been on Microsoft's Xbox, which generated a huge number of subscribers to Netflix.

"We believe Xbox's contribution to Netflix's fourth-quarter results is substantial," says Quarles; Microsoft and Netflix are very happy with the arrangement, she adds. "Our checks indicate the service has been an important factor in driving up Xbox gold subscriptions." So she expects that when Microsoft and Netflix renegotiate an extension of the agreement, which lapses in the second half of 2009, they are apt to agree on a more expanded business arrangement.

Microsoft's inclusion of Netflix in its media center and Xbox allows consumers to more easily sign up for the service, stream movies to their personal computers, and catalog the list of movies in their Netflix queue.

Quarles' 12-month price target for Netflix's stock of 51 is based on her 2009 earnings forecast of $1.70 a share on revenues of $1.6 billion, and $2.05 a share in 2010 on revenues of $1.9 billion. up from 2008's $1.32 a share on $1.3 billion.

Without doubt, Americans' undiminished romance with Hollywood and movies is driving Netflix's robust earnings and sales growth. And investors are counting on Netflix to benefit significantly from the continuing trend away from brick-and-mortar video rental stores to online subscription services.

Ultimately, investors who subscribe to the notion that Netflix is not only here to stay but also will expand broadly along with the widening digital world may wish to put the shares in their queue.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.