Netflix: Growth At All Costs (Chart Of The Day 10)

Subscriber and Revenue Growth Stay Strong

Netflix(NFLX) is an excellent gauge for how much investors are willing to pay for growth.   So far, NFLX has delivered.  The two charts of subscriber growth show the exponential increase in customers.   (https://ir.netflix.com/financials/quarterly-earnings/default.aspx).

Several days ago, NFLX raised prices for streaming content by 13% to 18%, signaling confidence in the subscriber base.  This was the second price increase in 2 years.

For its HUGE hit, “Bird Box”.  Netflix reported 80 million views in its first four weeks.  The company is becoming a force in producing original material. (https://s22.q4cdn.com/959853165/files/doc_financials/quarterly_reports/2018/q4/FINAL-Q418-Shareholder-Letter.pdf).

The price increase was met by sizable investor enthusiasm.  The stock, which traded down to $230 in late December, recently soared 50% to more than $350.  The price increase raised the odds that 4th quarter results would beat forecasts.

Yesterday, NFLX reported 4th Quarter results.  Revenues were about $4.2 Billion, a 5% increase from the 3rd Q and a 25% gain over the prior year.  Paid subscription additions met forecasts.  Domestically Netflix added 1.5 million viewers, and 7.3 million internationally.

Going forward, the Company guided a bit lower but still forecast revenues of $4.4 Billion in Q1 of 2019.  On a percentage basis, forecasted growth is slowing its torrid pace.

The price increase will NOT immediately lead to higher revenue.  For now, it only impacts NEW subscribers.  Existing accounts will be phased in and eventually pay the higher amount.  The company does not anticipate much “churn” or cancellation from the price hike.  That may prove to be overly optimistic.  Consumers have numerous low-cost options already, including YouTube,  Amazon Prime, HULU and ROKU.

Streaming Companies Sport Pricey Valuations

The subscription model is prized by investors.  The consistency of monthly income commands a premium to the less predictable cash flows of a cyclical company.  If the income is also growing quickly, investors will really pay up.

Streaming appears to be in its infancy but the field is about to become more crowded.  Growth in subscriptions appears to drive value rather than cash flow or earnings. Therefore, the more traditional measures of value based on earnings are not relevant. NFLX, for example, has a price/earnings (PE) ratio of more than 100 as does WWE.  The others are still unprofitable.

Valuation, as a result is less straightforward.   All of these companies BLEED CASH whether they show a profit or not.  There is CASH FLOW to discount.  Therefore, the ability of management to deliver growth is about the only quantifiable metric investors have to establish value.

Netflix is by far the largest and most expensive of the public streaming companies.  With about 150 Million subscribers worldwide, it is currently valued at about $1000 per subscriber ($154 Billion/ 150 Million).  Put differently, with revenue per account close to $10 per month, that’s 100 times monthly revenue.

Company                          Market Cap                               Price/Sales

Netflix                                       $154 B                                                10.34

World Wrestling   Ent.          $6.4 B                                                  7.33

Roku                                          $4.5 B                                                  6.94

Spotify                                       $2.4 B                                                 4.22

Pandora (P)                              $2.3 B                                                  1.54

A couple of the streaming companies, NFLX, WWE and P are featured in our slide show below.   Neither ROKU nor Spotify have not been publicly traded for very long.  The sector has produced BIG winners and losers.

The Cost of Growth

 

Netflix employs a very aggressive strategy to grow its base of business.  And, an expensive one.  Growth is VERY expensive. This year’s price tag is a “CASH FLOW” loss of $2.7 Billion.  The company expects to lose ANOTHER $3 Billion in Cash next year. (https://www.zerohedge.com/news/2019-01-17/netflix-slides-after-earnings-miss-light-guidance-it-burns-15-million-cash-daily).

How does a Company report POSITIVE NET Income exceeding $1 Billion and yet BURN nearly $3 Billion?  By spending lavishly on “content” including pledging funds up front to produce original movies and series.

In 2018, NFLX spent more than $13 Billion on acquiring content to be streamed.       (https://ir.netflix.com/financials/quarterly-earnings/default.aspx).  Growth is VERY expensive.

Netflix projects that 2019 will be the peak in negative cash flow.  Operations are expected to contribute more to funding growth by 2020.  Investors have fully priced-in the ability of the Company to produce this “cash flow turnaround”.

Is Netflix Overreaching?

The Company relies on increased borrowing to fund is sprawling empire.  Long term debt as of December 31, 2018 was $10.6 Billion versus $6.5 Billion a year ago.  Interest expense is now running at more than $500 Million per year. Growth is VERY expensive.

In addition, NFLX enters into long term binding contracts with providers of content.   As of the most recent SEC filing, the Company estimated these obligations exceeded $17 Billion.  (https://www.sec.gov/Archives/edgar/data/1065280/000106528018000069/q4nflx201710k.htm).

These contracts are fixed commitments like debt and elevate the cost structure.  Thus far, the Company’s aggressive spending has been successful, but the risks for investors will increase.

If included with long term debt, the fixed obligations of the Company are approaching $30 Billion.  Netflix has FAR LESS margin for error with the additional leverage it is taking on.  The risks are high and getting higher.

A HUGE risk is that of heightened competition.  Disney is expected to launch its own streaming service.  But, equally problematic is that its content will become exclusive to Disney’s own streaming effort.  (https://www.cnn.com/2019/01/15/media/netflix-raising-prices/index.html). Other providers of content such as NBC/Universal may follow suit.

Netflix, for the moment, appears to be pretty fully priced. Risk is rising and may not be fully appreciated.  The LARGE Capital requirements for acquiring and producing content make the Company very vulnerable to economic reversal.   The nosebleed valuation leaves little margin for error and investors VERY EXPOSED to RISK.  Growth, is VERY expensive.

Information, however, is always a good investment.  That’s our job.

Be Informed, Not Misled!

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