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

Opdateret: 22. jan.

It is usually wise to invest in market leaders, and Netflix is a prominent player in the video streaming industry with significant potential for growth. However, investors seem to disagree on whether Netflix is a good investment. Bill Ackman got out of his investment quickly, while Phil Town has been buying the stock. Warren Buffett, who owns a competitor, stated in an interview on CNBC in April 2023 that "the streaming business is tough." 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. If you want to buy shares or fractional shares in Netflix, you can do so at eToro.

Netflix is defined as an over-the-top content and production platform. It was founded in 1997 by Reed Hastings and Marc Randolph and is headquartered in California. I believe most people are familiar with Netflix, so there is no need to delve further into the company's operations. However, it may be useful to know that Netflix generates 45% of its revenue in North America, 31% of its revenue in Europe, the Middle East, and Africa, 13% of its revenue in Latin America, and 11%of its revenue in the Asia-Pacific region. Netflix is a widely recognized brand, so much so that it has become synonymous with the phrase "Netflix and chill," which is often used as a euphemism for engaging in sexual activity. It gives Netflix a certain brand moat. Management has also discussed their competitive advantage, or "moat," in a recent earnings call. They mentioned that they view themselves as a unique product that cannot be easily replaced by alternatives.Nonetheless, I would argue that Netflix's brand moat is relatively weak as it is easy for customers to switch from one company to another if a streaming service does not provide the content they like. It is something I do myself, as my choice of streaming service depends on the TV show I want to watch. Thus, I don't think that Netflix has as strong a moat as I would like.

Netflix has two co-CEOs, 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 in 2013, while also leading the teams that acquired and created some of Netflix's biggest 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 one of Time Magazine's 100 Most Influential People. He also seems to be popular among employees, as he has an employee rating of 81/100 at Comparably, which places him in the top 5% of companies of similar size. Greg Peters first joined Netflix in 2008 and became the co-CEO in January 2023. Before being named co-CEO, Greg Peters held various positions at Netflix, including Chief Operating Officer and Chief Product Officer. Greg Peters has been responsible for Netflix's global partnerships with consumer companies, internet service providers, and multi-channel video programming distributors that enable Netflix to deliver its products across various devices and platforms. Besides being the co-CEO of Netflix, Greg Peters also serves on the boards of 2U Inc and DoorDash. We don't have much information on Greg Peters yet, as he is still new to the role. I believe that combining the different experiences of Ted Sarandos and Greg Peters is a good idea and will work well for Netflix in the future. Thus, I feel comfortable with the management at Netflix. And it is worth remembering that the former CEO and co-founder, Reed Hastings, will still serve as the executive chairman of the board.

I believe that Netflix has a brand moat, although it may be slightly weaker than we would prefer. However, I really like the management. Now, let us investigate the numbers to determine if Netflix meets 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 return on invested capital (ROIC) above 10% in all years. Historically, Netflix has had an underwhelming return on invested capital (ROIC). However, they have moved in the right direction since 2017 and have lived 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 return on invested capital (ROIC) moving forward. I believe that monitoring ROIC is important to determine if Netflix maintains a ROIC above 10% for investors.

The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actualnumbers and the percentage growth year over year. These numbers are much more encouraging, as Netflix has managed to grow its equity year over year in the last 10 years. And even more impressive, Netflix has continuously managed to deliver a growth rate higher than 10% each year. While the return on invested capital (ROIC) was underwhelming, these numbers are promising.

Finally, we will investigate the free cash flow. In short, free cash flow refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all its financial obligations. I use the margin to better understand it. Free cash flow yield refers tothe amount of free cash flow per share that a company is projected to generate in relation to its market value per share.Netflix hasn't delivered the desired level of free cash flow that one would expect from a company you would like to invest in. In the past decade, Netflix has only achieved positive free cash flow in two out of the last ten years. Management has stated, however, that they expect to achieve positive free cash flow from now on. Levered free cash flow margin is also low in the years when Netflix has generated positive free cash flow. Additionally, the low free cash flow yield suggeststhat the stock is expensive, but we will discuss this further later on.

Another important aspect to consider is the level of debt, and it is crucial to determine whether a business has a manageable debt that can be repaid within a period of 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 level than I would prefer. It is worth noticing, though, that Netflix has usually had a much higher debt than they do now. While I wouldn't label Netflix's 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 mentioned in the paragraph discussing the moat, I believe the streaming industry is highly competitive, making it difficult to prevent customers from switching between companies. The lack of a strong moat poses a challenge in retaining customers. By the end of 2022, Netflix has 231 million paying customers, compared to 220 million on Amazon Prime Video, 164 million on Disney+, and 96,1 million on HBO. Netflix has determined that they have 800-900 million households around the world as potential customers. While many customers may have more than one subscription, these numbers indicate 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's largest markets, it could hurt their profitability as customers would likely reduce their video streaming subscriptions. A strong U.S. dollar can impact Netflix's profitability as they generate most of their revenue outside of the United States.In their fourth quarter results in 2022, management mentioned that their 2% revenue growth would have been a 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 is also plenty of potential for Netflix moving forward. One is a growing market. A market analysis report from Grand View Research projects the global video streaming market size to grow at a compounded annual growth rate (CAGR) of 18.5% until 2030. Not only is the global video streaming market size growing, but Netflix also has plenty of room to grow in the current market. Currently, Netflix accounts for 8% of TV screen time in the U.S., while its share of TV screen time is even smaller in other large markets such as Brazil and Mexico, at 4% each. Netflix believes that "ultimately, the vast majority of time spent on TV will happen via streaming."Hence, they have a long runway for growth if management makes the right decisions. Mobile Gaming. Netflix entered the world of mobile gaming in November 2021 and has already released 55 games since its launch. Netflix expects to launch approximately 40 more games in 2023 and has an additional 70 games in development. Netflix expects that mobile gaming will attract more subscribers in the long term. Furthermore, the size ofthe mobile gaming market is expected to grow at a compounded annual growth rate (CAGR) of 15.8% until 2026. Monetizing Shared Accounts. Management believes that there are over 100 million households that watch Netflix through a shared account. Management hopes to monetize these shared accounts and has been testing this strategy in some Latin American countries. Subscribers in these countries have the option to pay approximately $3 to share their account with a different household. Netflix expects to introduce changes to its subscriptions in the U.S. in 2023, and this could be a strategy to monetize shared accounts, ultimately boosting 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). The estimated future PE is 30 (which is double the growth rate, as the historical PE for Netflix has been higher). Additionally, we have already established a minimum acceptable return rate of 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $298,5 We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Netflix at a 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 were 408. I tried to look through their annual report to see how much of the capital expenditures were used for maintenance. I couldn't find it, but as a rule of thumb, you can expect 70% of the capital expenditures to be used for maintenance. This means that 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 as follows: (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 Netflix's Free Cash Flow Per Share at 3.64 and a growth rate of 15%, if you want to recoup your purchase in 8 years, the Payback Time price is $57.46.

I do believe that Netflix is a good company, and I really like the management. However, I believe there are risks that need to be considered, especially the weakness in the moat, which should shield Netflix from competition. Speaking of competition, it is fierce in the industry. While Netflix may be considered the best in class, there is a risk moving forward as subscribers easily switch between services. Personally, I'm also a bit concerned about the ROIC, and I prefer a business with a higher ROIC. 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 gaming business will perform in the future. If I were to invest in a stock in the streaming sector, it would be Netflix. However, I believe there are too many risks involved. Thus, I'm not interested in buying Netflix stocks now.

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