For ameliorate or worse, Netflix has changed non but the amusement business, but also the means that nosotros (the audience) lookout adult man television. In the process, it has also enriched its investors, every bit its marketplace capitalization climbed to $139 billion inward March 2018 together with fifty-fifty after the marketplace correction for the FANG stocks, its value is substantial plenty to brand it i of the largest amusement fellowship inward the world. Among the FANG stocks, amongst their gigantic marketplace capitalizations, it remains the smallest fellowship on both marketplace value together with operating metrics, but it has almost every bit large an affect on our daily lives every bit its larger peers.
The History
This may come upwards every bit a surprise to some, but Netflix has been publicly listed for longer than Facebook or Google. The difference betwixt Netflix together with these companies is that it’s climb to stardom has taken to a greater extent than time.
Don't larn me wrong! Netflix was a real goodness investment betwixt 2003 together with 2009, increasing its marketplace capitalization past times 33.36% a twelvemonth together with its marketplace capitalization past times virtually $3 billion, during that period. However, it became a superstar investment betwixt 2010 together with 2017, adding virtually $120 billion inward value over the period, translating into an annual cost appreciation of to a greater extent than than 50% a year.
The fuel that Netflix has used to growth its marketplace capitalization is its subscriber base, every bit amongst the other FANG stocks, the fellowship seems to receive got establish the undercover to last able to scale up, every bit it gets larger. That subscriber base, inward turn, has allowed the fellowship to growth its revenues over time, every bit tin last seen inward the painting below, summarizing Netflix’s operating metrics.
You tin bill me of over analyzing this chart, but it captures to me the essence of the Netflix success story. While Netflix has been able to grow revenues inward each of the 3 consecutive five-year fourth dimension periods, 2002-2006, 2007-2012 together with 2013-2017, that it has been existence, the fellowship has been faced amongst challenges during each period, together with it has adapted.
- DVDs inward the Mail: In the outset five-year period, 2002 through 2006, the fellowship mailed out DVDs together with videos to its subscribers, challenging the video rental business, where brick together with mortar video rental stores represented the condition quo, together with Blockbuster was the dominant player.
- The Rise of Streaming: It was betwixt 2007 together with 2012, where the fellowship came into its own, every bit it took wages of changes inward engineering scientific discipline together with inward client preferences. First, every bit engineering scientific discipline evolved to allow for the streaming of movies, Netflix adapted, amongst a few fossil oil spots, to the novel technology, spell its brick together with mortar competitors imploded. Second, spell Netflix saw a drib inward revenue growth that was non unexpected, given its larger base, it also saw its content costs rising at a faster charge per unit of measurement than revenues, every bit content providers (the motion painting studios) starting charging higher prices for content.
- The Content Maker: In hindsight, the studios belike want that they had non squeezed Netflix, because the fellowship reacted past times taking to a greater extent than command of its ain destiny inward the 2013-2017 fourth dimension period, past times shifting to master copy content, outset amongst tv set serial together with afterward amongst direct-to-streaming movies. The results receive got upended the amusement business, but to a greater extent than critically for Netflix, they demonstrate upwards inward a critical statistic. For the outset fourth dimension inward its existence, Netflix saw content costs rising at a charge per unit of measurement slower than its growth inward revenues, amongst operating turn a profit margins, both before together with after R&D reflecting this development.
The State of the Game
We tin ground whether Netflix is a goodness or a bad investment, but at that spot is no declaration that the means movies together with tv set larn made has been changed past times the company’s practices. It is the residue of the amusement concern that is trying to accommodate to the Netflix streaming model, every bit evidenced past times Disney’s acquisition of BAM Media together with Fox Entertainment. If I were to summarize where Netflix stands right now, hither would last my cardinal points:
1. It's a large spender on content: In 2017, Netflix spent billions on the content that it delivers to its subscribers, together with the extent of its spending tin last seen inward its fiscal statements. The means that Netflix accounts for its content expenditures does complicate the measurement, since it uses 2 dissimilar accounting standards, i for licensed content together with i for productions, but it capitalizes together with amortizes both, albeit on dissimilar schedules, together with based upon viewing patterns. The gap betwixt the accrual (or amortized) cost (shown inward the income statement) together with the cash spent (shown inward the declaration of cash flows) on content tin last seen inward the graph below.
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| Netflix 10K - 2017 |
In 2017, Netflix spent almost $9.8 billion on content, though it expensed exclusively $7.7 billion inward its income statement. If this deviation continues, together with at that spot is no ground to believe that it volition not, Netflix’s profits volition last to a greater extent than positive than their cash flows past times a substantial amount. Note that this deviation should non last taken (necessarily) every bit a sign of deception or accounting game playing. In fact, if Netflix is beingness reasonable inward its amortization judgments, i means to read the difference of $2.14 billion ($9.8 inward cash expenses minus $7.66 billion inward accrual expenses) is to sentiment it every bit the equivalent of majuscule expenditures at Netflix, since it is expense incurred to attract together with maintain subscribers.
2. An increasing amount of that spending goes to master copy content: The determination past times Netflix to attain some of its ain content inward 2013 triggered a shift towards master copy content that has picked upwards speed since that year. In 2017, the fellowship spent $6.3 billion on master copy content, putting it amid the orbit spenders inward the amusement business:
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| Biggest Spenders on Entertainment Content inward 2017 |
The stair is non letting up. In the outset quarter of 2018, Netflix introduced xviii novel tv set serial together with delivered 12 novel seasons of existing series, prodigious output past times whatever studio’s standards. There are 3 reasons for the Netflix motion into the content business.
- The first, referenced inward the in conclusion section, is to gain to a greater extent than command over content costs together with to last less exposed to motion painting studio cost hikes.
- The instant is that Netflix has been using the information that it has on subscriber tastes non exclusively to direct content at them, but to attain novel content that is tailored to viewer demands.
- The tertiary is that it introduces stickiness into their concern model, a cardinal ground why novel subscribers come upwards to the fellowship together with why existing subscribers are reluctant to abandon it, fifty-fifty if subscription fees function up.
Netflix has moved beyond tv set shows to making straight-to-streaming movies, spending $90 meg on Bright, a motion painting that yet its lackluster reviews, signaled the company’s ambitions to last a major histrion inward the motion painting business.
3. Netflix has been goodness at playing the expectations game: One characteristic that all of the FANG stocks merchandise is that rather than allow equity question analysts frame their stories together with stair out their success, they receive got managed to frame their ain stories together with brand investors together with analysts play on their terms. Netflix, for instance, has managed to brand the expectations game all virtually subscriber numbers, together with every earnings study of the fellowship is framed about these numbers, amongst less attending paid to content costs, churn rates together with negative cash flows. After its most recent earnings study inward January, the stock cost surged, every bit the fellowship reported an growth of 8.3 meg inward subscribers, good to a higher house expectations.
4. The fellowship is globalizing: One lawsuit of making it a numbers game, which is what Netflix has done past times keeping the focus on subscribers, is that you lot receive got to function where the numbers are, together with for ameliorate or worse, that has meant that Netflix has had to function global, amongst Asia beingness the woman raise lode.
At the cease of 2017, Netflix had to a greater extent than subscribers exterior the United States of America than inward the US, together with it is bringing its costless spending ways together with its views on content evolution to other parts of the world, peradventure bringing Bollywood together with Hollywood closer, at to the lowest degree inward terms of shared problems.
In summary, Netflix has built a concern model of spending immense amounts on content, using that content to attract novel subscribers, together with and hence using those novel subscribers every bit its pathway to marketplace value. It is clear that investors receive got bought into the model, but the model is also i that burns through cash at alarming rates, amongst no shine or close term escape hatch.
The Valuation
In keeping amongst the focus on subscriber numbers that is at the centre of the Netflix story, I volition value Netflix amongst the subscriber-based approach that I used to value Spotify a few weeks agone together with Uber together with Amazon Prime in conclusion year.
Cost Breakdown
The cardinal to getting a subscriber-based valuation of Netflix is to outset recess its overall costs downward into (a) costs for servicing existing subscribers, (b) the cost of acquiring novel subscribers together with (c) a corporate cost that cannot last straight related to either servicing existing subscribers or getting novel ones. I started amongst the Netflix 2017 income statement:
Since Netflix does non recess its costs downward into my preferred components I made subjective judgments inward allocating these costs, treating G&A costs every bit expenses related to servicing existing subscribers together with marketing costs every bit the costs of acquiring novel subscribers. With content costs, I started outset amongst the $2,146 meg difference betwixt the cash content cost together with expensed content cost together with treated it also every bit business office of the cost of acquiring novel subscribers. With the expensed content cost of $7,600 million, I assumed that exclusively 20% of these costs are straight related to subscribers together with treated that portion every bit business office of the cost of servicing existing subscribers together with that the remaining 80% would larn business office of the corporate cost, inward conjunction amongst the investment inward engineering scientific discipline together with development. One cardinal difference betwixt the Netflix together with Spotify cost models is that most of the content costs are fixed corporate costs for Netflix but almost all content costsare variable costs for Spotify, since it pays for content based upon how its subscribers heed to it, rather than every bit a fixed fee.
Value of an Existing Subscribers
My determination to care for most of the content content costs every bit a corporate cost has predictable consequences. The costs associated amongst private subscribers are exclusively the G&A costs together with 20% of content costs, together with the break is small, relative to the revenues that Netflix generates per subscriber:
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| Download spreadsheet |
H5N1 delineate that Netflix has built, peradventure amongst its master copy content, is that it has reduced it's churn charge per unit of measurement (the loss of existing customers), each twelvemonth since 2015. In 2017, the annual renewal charge per unit of measurement for a Netflix subscription was virtually 91%, together with that break improved fifty-fifty to a greater extent than across the 4 quarters. In my subscriber-valuation, I receive got used a 92.5% renewal rate, for the life of a subscriber, assumed to last fifteen years. I volition assume that Netflix investments inward master copy content volition give it the pricing ability to growth annual revenue per subscriber (G&A together with the 20% of content costs), which was $113.16 inward 2017, at 5% a year, spell keeping the growth charge per unit of measurement inward annual expenses per subscriber at the inflation charge per unit of measurement of 2%. I gauge after-tax operating income each year, using a global average taxation charge per unit of measurement of 25%, together with discount it dorsum at a 7.95% cost of majuscule (estimated for Netflix, based upon its concern together with geographic mix, together with debt ratio) to derive a value of $508.89 subscriber together with a total value of $59.8 billion for Netflix’s 117.6 meg existing subscribers.
Value of New Subscribers
To value a novel subscriber, I outset estimated the total cost that Netflix spent on adding novel subscribers past times adding the total marketing costs of $1,278 meg to the capitalized portion of the content costs of $2,142 million, together with and hence divided this amount past times the gross growth inward the break of subscribers (30.84 million) during 2017, to obtain a cost of $111.01 for acquiring a novel subscriber. I together with hence internet that break out from the value of an existing subscriber to larn inward at a value of $397.88/new subscriber right now; I assume that this value volition growth at the inflation charge per unit of measurement over time.
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| Download spreadsheet |
I assume that Netflix volition maintain to add together novel subscribers, adding 15% to its internet subscriber rolls, each twelvemonth for the outset 5 years, together with 10% a twelvemonth for years half dozen through 10, before settling into a steady terra firma growth charge per unit of measurement of 1% a year. Discounting the value added past times novel subscribers at a higher cost of majuscule of 8.5%, reflecting the greater uncertainty associated amongst novel subscribers, yields a total value of $137.3 billion for novel subscribers.
The Corporate Drag
The concluding slice of the puzzle is to pick out inward the corporate costs that nosotros assumed could non last straight linked amongst subscriber count. In the illustration of Netflix, the technology & evolution costs together with 80% of the expensed content, that nosotros position into this corporate cost category amounted to $6.13 billion inward 2017 together with the path that these costs follow inward the time to come volition determine the value that nosotros attach to the company.
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| Download spreadsheet |
I assume that engineering scientific discipline & evolution costs volition grow 5% a year, but it is on the content cost factor that I struggled the most to gauge a growth rate. I decided that the accelerated spending that Netflix had inward 2017 together with continued to receive got inward 2018 reverberate Netflix’s elbow grease to larn standing inward the business, together with that spell it volition maintain to pass large amounts on content, the growth charge per unit of measurement inward this portion of the content costs volition drib to 3% a year, for the adjacent 10 years. Note that fifty-fifty amongst that depression growth rate, Netflix volition last consistently amid the orbit 5 spenders inward the content business, spending to a greater extent than than $100 billion on master copy content over the adjacent 10 years. Discounting dorsum the after-tax corporate expenses dorsum at the 7.95% cost of capital, yields a corporate cost drag of $111.3 billion.
The Netflix Valuation: The One Number
To value Netflix, I pick out together the value of existing together with novel subscribers together with internet out the corporate cost drag. I also subtract out the $6.5 billion inward debt that the fellowship has outstanding together with the value of equity options granted over fourth dimension to its employees.
The value per part of $172.82 that I gauge for Netflix is good below the stock cost of $275, every bit of Apr 14, 2018. My value reflects the story that I am telling virtually Netflix, every bit a fellowship that is able to grow at double digit rates for the adjacent decade, amongst high value added amongst novel users, spell bringing its content costs nether control. I am sure enough that your views on the fellowship volition diverge from mine, together with you lot are welcome to role my Netflix subscriber valuation template to come upwards to your ain conclusions.
It is worth taking a pause, together with considering the differences betwixt Netflix together with Spotify, both subscription-based concern models, that depict their value from immense subscriber bases.
- By paying for its content, both licensed together with original, together with using that content to function after subscribers, Netflix has built a to a greater extent than levered concern model, where subscribers, both novel together with existing, receive got higher marginal value than at Spotify, where content costs are tied to subscribers listening to music.
- The Netflix model, which is increasingly built about master copy rather than licensed content, provides for a stronger competitive edge, which should demonstrate upwards inward higher renewal rates together with to a greater extent than pricing power, adding to the value per subscriber, both existing together with new.
- The Netflix model volition deliver higher value from subscription growth than the Spotify model, but it comes amongst a greater downside, because a slackening of that growth volition larn out Netflix much deeper inward the hole, amongst to a greater extent than negative cash flows, than it would Spotify.
In my before post on Google, I noted that every fellowship has a value driver, i break that to a greater extent than than whatever of the others determines value. In the illustration of Netflix, the cardinal value driver, inward my view, is content costs. My value per part is premised non but on high growth inward subscribers together with continued subscriber value, but also on content costs growing at a much lower charge per unit of measurement (of 3%) inward the future. To illustrate the sensitivity of value per part to this assumption, I varied the growth charge per unit of measurement inward content costs together with calculated value per share:
To illustrate the dangers to Netflix of letting content costs grow at high rates, annotation that the company’s equity value becomes negative (i.e., the fellowship goes bankrupt), if content costs grow at high rates, relative to revenue growth, amongst double digit growth rates creating catastrophic effects. If Netflix is able to cap the costs at 2017 levels inward perpetuity, the estimated value per part is some $216, at the base of operations illustration growth charge per unit of measurement of 15%, together with if it is able to cut back content costs inward absolute terms over time, it is worth fifty-fifty more. In my view, investing inward Netflix is less a bet on the fellowship beingness able to deliver subscriber and/or revenue growth inward the time to come together with to a greater extent than i on the time to come path of content costs at the company.
The Decision
There is no doubtfulness that Netflix has changed the means nosotros lookout adult man tv set together with the movies, together with it is changing the movie/TV concern inward pregnant ways. By competing for talent inward the content business, it is pushing upwards costs for its competitors together with amongst its direct-to-streaming model, putting pressure level on motion painting theaters together with distribution. That said, the amusement concern remains a daunting one, because the talent is expensive together with unpredictable, together with egos run rampant. The history of newcomers who receive got come upwards into this concern amongst opened upwards wallets is that they larn out amongst empty ones. For Netflix to escape this fate, it has to demonstrate dependent area inward controlling content costs, together with until I run into evidence that it is capable of this discipline, I volition rest a subscriber, but non an investor inward the company.
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