Netflix Valuation Is In The Stratosphere

2017/07/25

On July 17th 2017, Netflix shares jumped 13% to a record high of $183 after the company reported better than expected subscriber growth for the second quarter. Wall Street analysts are valuing Netflix on users’ growth and other futile parameters such as global awards and contents while ignoring the real metrics such as earning power and financial leverage.
Here’s a summary of what analysts had to say:

“We believe 2Q17 may have been NFLX’s strongest content quarter ever, leading to 5.2M global streaming net adds coming in well above our projection of 3.2M, with significant upside in both US & Int’l,” JPMorgan analyst Doug Anmuth.

“Overall, NFLX 2Q and guidance continues the strong subscriber trends from the last 3 quarters, as they have taken advantage of the drawing power of originals to generate strong subscriber growth, while also taking a successful material price hike, a very powerful combination,” Pivotal Research Group analyst Jeffrey Wlodarczak.

“We are increasingly confident in our bullish outlook for Netflix, with the view that the company continues to build on its defensible position as the largest distributor of content globally,” Nomura Instinet analyst Anthony DiClemente.
As value investors, we tend to value companies on the basis of fundamentals not popularity. We try not to get caught up in Wall Street hysteria.

According to Yahoo Finance, Netflix stock price closed today at $186.79 giving the company a price tag of $80.9 billion. With 104 million users, speculators are essentially paying $778 million per user who’s generating a miserable $1.80 in net profit.

Market Cap Market Cap per User Net Income Net Income per User
$80.9 Billion
$778
$187 Million
1 Dollar and 80 Cents

Now if we compare NFLX to the industry …

A speculator is paying 230 multiple for Ntflix, a company that has an operating margin of 6% and a mere 2% in net profits. These anemic operating and net margins are a clear sign that Netflix has no moat around its business, hence no price control. In a sense Netflix is a commodity business that sells for insane valuations.

 

 

Metrics netflix industry
Price/Earnings
230
22
Return On Assets (ROA)
2.6
6.5
Operating Margins %
6
20
Net Margin %
2.11
11

 *Morningstar.com

 If we dig a little bit deeper and follow the cash …

Netflix is losing cash at an alarming rate, the company lost $750 million in 2015, close to $1.5 billion last year, and already they burned close to $880 million since January 2017. To fund operations, the company is issuing new shares and new debts ($2.5 billion since 2015).

 

 

 

Fiscal Year 2015 Fiscal Year 2016 1st and 2nd quarter 2017
Cash Flow From Operations
$-749 Million
$-1.47 Billion
$-878 Million
Debt Issued
$1.5 Billion
$1 Billion
-

*Netflix 2016 annual report and 2Q17 quarterly report

 

Netflix is hemorrhaging money, in order to attract new users, it needs to create more contents, and the more contents they create the more cash they burn. Also, the company issues tons of stock options to insiders, in their 2016 annual report, the company issued $147 million in stock-based compensation, the equivalent of 93% of their GAAP net income!

 

In summary, the only plausible way for Netflix to warrant its valuation and hence its market cap of $80 billion, is if they sign EVERY single citizen of North America, South America, The Caribbean, Europe, Oceania AND India as follows:

 

 

 

Reality Assumption
Users
104 Million
3 Billion
Average Yearly Membership
$90
$90
Gross Revenue (Users x Membership)
$9.3 Billion
$270 Billion
Net Income (0.02% of revenue)
$186 Million
$5.4 Billion
Market Cap (Net Income x P/E)*
$2.7 Billion
$81 Billion

*Assuming a P/E of 15

 

PS: We are not holding nor intend to hold any Netflix security for the foreseeable future

 

Sid El Mehdi Lembirik

Managing Partner,

 

Lembirik Group Investments

 

 

 

 

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