Netflix: Is it time to invest in this market leader?

It is usually good to invest in market leaders, and Netflix is a market leader in video streaming with plenty of room to grow. However, investors seem to disagree if Netflix is a good investment. Bill Ackman got out of his investment fast, while Phil Town have been buying the stock. Warren Buffett owns a competitor and in an interview on CNBC in April 2023, he said that "Streaming is not really a good business". In this analysis, I will investigate if Netflix is a buy and at what price.

This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and briefly go through why the company has meaning to me. I have changed the format of the analysis a bit to try to make it shorter and with less numbers. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.

For full disclosure, I should mention that at the time of writing this analysis, I do not own shares in Netflix or in any of their competitors. If you would like to copy my portfolio or see what shares I own, you can read about how to do so here.

Netflix is defined as an over-the-top content platform and production platform. It was founded in 1997 by Reed Hastings and Marc Randolph and is located in California. I believe most people know about Netflix, so I see no reason to go deeper into what the company does. However, it may be useful to know that Netflix generates 45 % of their revenue in North America, 31 % of their revenue in Europe, Middle East, and Africa, 13 % of their revenue in Latin America, and 11 % of their revenue in Asia-Pacific. Regarding their moat, Netflix is a well-known brand, which is so well-known that it is even used as part of a euphemism for sexual activity being "Netflix and chill". It gives Netflix some sort of brand moat. Management has also touched about their moat in a recent earnings call, as they mentioned that they see themselves as a non-substitute good. Nonetheless, I would argue that Netflix's brand moat is relatively week as it is easy for the customer to switch from one company to another, if one streaming service doesn't provide the content you like. It is something I do myself, as my choice of streaming service depends on what tv show I want to watch. Thus, I don't think that Netflix has a strong a moat as I would like.

Netflix has two co-CEO in Ted Sarandos and Greg Peters. Ted Sarandos first joined Netflix in 2000 and became the co-CEO alongside co-founder Reed Hastings in 2020. Besides being the co-CEO, he is also the chief content officer at Netflix. Ted Sarandos led Netflix into original content production back in 2013, while also leading the teams that acquired and created some of Netflix' largest successes' such as Stranger Things, Squid Game, La Casa de Papel, The Witcher, The Irishman, and ROMA. He is recognized as an innovator and has previously been named as one of Tome Magazine's 100 Most Influential People. He also seems to be popular among employees as he gets an employee rating at 81/100 at Comparably, which places him in top 5 % of similar sized companies. Greg Peters first joined Netflix in 2008 and became the co-CEO in January 2023. Before being named co-CEO, Greg Peters held different positions in Netflix such as Chief Operating Officer and Chief Product Officer. Greg Peters has been responsible for Netflix' global partnerships with consumer companies, internet service providers, and multi-channel video programming distributors that enable Netflix to deliver their products across various devices and platforms. Besides being the co-CEO of Netflix, Greg Peters also serves on the boards 2U Inc and DoorDash. We don't have much information on Greg Peters yet, as he is still new in the role. I believe that combining the different experience that Ted Sarandos and Greg Peters have is a good idea and will work well for Netflix moving forward. Thus, I feel comfortable with the management at Netflix. And it is worth remembering that former CEO and co-Founder Reed Hastings will still be executive chairman of the board.

I believe that Netflix has a brand moat albeit a bit weaker than we would like. However, I really like the management. Now let us investigate the numbers to see if Netflix does live up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.

The first number I will investigate is the return on investment capital, also known as ROIC. Ideally, you would like to see a ROIC above 10 % in all years. Historically, Netflix has an underwhelming ROIC. However, they have moved in the right direction since 2017, and does live up to the 10 % ROIC in the last three years. Nonetheless, I cannot help feeling a bit underwhelmed by these numbers and I would like to see a higher ROIC moving forward. I believe that ROIC should be monitored to see if Netflix continues to deliver a ROIC above 10 % if you are invested in Netflix.

The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. These numbers are much more encouraging as Netflix has managed to grow their equity year over year in the last 10 years. And even more impressing, Netflix has continuously managed to deliver a higher than 10 % growth each year. While ROIC was underwhelming, these numbers are promising.

Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has left remaining after paying all its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. Netflix hasn't delivered the free cash flow that you would like to see from a company you invest in. In the last ten years, Netflix only managed to deliver positive free cash flow in two years. Management has stated though that they expect to be cash flow positive from now on. Levered free cash flow margin is also low in the years that Netflix has been free cash flow positive, while the low free cash flow yield indicates that the stock is expensive, but it is something we get back to later.

Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. Doing the calculation on Netflix, I can see that Netflix has 3,2 years of earnings in debt. Thus, Netflix has a higher debt than I would like to see. It is worth noticing thought that Netflix has usually had a much higher debt than they do now. While I wouldn't label Netflix' debt as concerning, it would still be something I would monitor moving forward, if I invested in Netflix.

Like every other company, Netflix is facing some risks. The most obvious risks come from competitors such as HBO, Amazon Prime and Disney+. As I wrote in the paragraph about the moat, I believe the streaming industry is very competitive and it is hard to keep competitors away, as you don't a have such a strong moat that keeps your customers from changing from one company to another. By the end of 2022 Netflix has 231 million paying customers compared to 220 million on Amazon Prime Video, 164 million on Disney+, 96,1 million on HBO. Netflix has determined that they have 800-900 million households around the world as potential customers, and while many customers will probably have more than one subscription, these numbers show that it is a competitive market. Macroeconomic factors. In previous letters to shareholders, management has mentioned that inflation, sluggish economic growth, and geopolitical events could have an impact on their business. If we see a recession in some of Netflix' largest markets, it could hurt their profitability as customers would probably cut down on video streaming subscription. A strong U.S. dollar. Netflix is making most of their revenue outside of the United States, and a strong dollar will impact their profitability. In their fourth quarter results in 2022, management mentioned that their 2 % revenue growth would have been 10 % growth on a foreign exchange neutral basis, while the 2 % decline in average paid memberships would have been a 5 % increase on a foreign exchange neutral basis.

It isn't all bad for Netflix and there are also plenty of potential for the Netflix moving forward. A growing market. A market analysis report from Grand View Research projects the global video streaming market size to grow by a compounded annual growth rate (CAGR) of 18,5 % until 2030. Not only is the global video streaming market size growing, but Netflix also have plenty of room to grow in the current market. Currently, Netflix is 8 % of the TV screen time in the U.S., while their TV screen time is even smaller in other large markets such as Brazil and Mexico at 4 % in each. Netflix believes that that "ultimately the vast majority of time spent on TV will be happen via streaming". Hence, they have a long runway for growth if management is right on that one. Mobile gaming. Netflix entered the world of mobile gaming in November 2021, and has already released 55 games since its launching. Netflix expects to launch about 40 more games in 2023 and has another 70 games in development. Netflix expects that mobile gaming will draw in more subscribers over the long-term. Furthermore, the mobile gaming market size is expected to grow by compounded annual growth rate (CAGR) of 15,8 % until 2026. Monetizing shared accounts. Management believes that there are over 100 million households that watched Netflix through a shared account. Management hopes to monetize these shared accounts and has been testing it in some Latin American countries, where subscribers could pay around $3 for sharing their account with a different household. Netflix expects to introduce changes in subscriptions in the U.S. in 2023, and it could be a way to monetize the shared accounts, which would boost revenue.

All right, we have gone through the numbers, potential and risk regarding Netflix, and now it is time for us to calculate a price for Netflix. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS at 9,95, which is the EPS from 2022. I chose an Estimated future EPS growth rate of 15 (which is lower than the 22 % that Finbox projects, but it is the highest I use), Estimated future PE 30 (which the double of the growth rate, as the historically PE for Netflix has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY", we come up with the sticker price (some call it fair value or intrinsic value) of $298,5, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Netflix at price of $149,25 (or lower obviously), if we use the Margin of Safety price.

Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The Operating Cash Flow last year was 2.026. The Capital Expenditures was 408. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 285,6 in our further calculations. The Tax Provision was 772. We have 445,347 outstanding shares. Hence, the calculation will be like this: (2.026 - -285,6 + 772) / 445,347 x 10 = $56,41 in TEN CAP price.

The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 3,64 and a growth rate of 15 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $57,46.

I do believe that Netflix is good company and I really like the management. However, I believe there are risks that needs to be considered, especially the weakness in the moat, which should shield Netflix from competition. Speaking of competition, it is fierce in the industry and while Netflix may be best in class, it is a risk moving forward as subscribers switch between services so easily. Personally, I'm also a bit concerned about the ROIC, and I personally prefer a higher ROIC business. Nonetheless, Netflix operates in a growing sector, and they still have plenty of room to grow moving forward. It will also be interesting to see how their mobile games business will do moving forward. If I should buy a stock in the streaming sector, it would be Netflix, but I think there are just too many risks. Thus, I'm not interested in buying Netflix stocks now.

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