Netflix Valuation: Buy The Dip

In recent years, Netflix (NFLX) has been a star performer on the stock market. In fact, if you had invested $1,000 in Netflix a decade ago — back when the price of a share was just $15.63 — your shares would be worth $40,430 today.

That’s just the latest in the saga of Netflix’s recent standout performance on the stock market, making it quite easy to see why investors are enamored with the streaming giant. As streaming has quickly become the primary distribution mechanism for movies, and TV, what’s next for Netflix valuation and its growth trajectory?

Netflix Economies Of Scale Boost Margins 

Netflix, Inc. has been publicly listed on NASDAQ as NFLX since 2002. Since its IPO, the company has shown a steady increase in share price.

Even during a global decline in the stock market as a whole, the company has continued to outperform its competitors. In 2021, Netflix has seen its stock prices rise by 25%.

The company’s success stems from a steady flow of smash hits, like Squid Game — the Korean thriller, which is on track to become the platform’s most streamed show.

The key metric for Netflix until recently was subscriber growth. In fact, the company was barely profitable until 2019 and its operating cash flows were in the red, leaving investors more concerned with growth and the potential for profitability in the future.

Since then, the situation has changed pretty drastically as earnings began to accelerate and revenue increased. Netflix now benefits from economies of scale as margins play an increasing role in the streaming service’s intrinsic value.

Netflix Business Model

Netflix’s business model is one that disrupted the media industry entirely, as well as the way people consume content forever.

If you’re an early Netflix adopter, you’ll remember having to wait a few days for your red Netflix DVDs to arrive in the mail — and the pain of waiting for your DVD to arrive back at Netflix HQ before you could order another one, depending what plan you were on. As technology and media consumption habits have evolved, so has the Netflix business model.

Netflix has actually been in business since 1998 — the days when movie rental stores like Blockbuster and Hollywood Video were packed with customers scouring the shelves for the latest releases on DVD or VHS, and don’t forget about the huge candy and popcorn selection conveniently located right next to the registers. A lot has changed since then, and now the thought of having to leave the house to go grab a physical DVD to watch a movie seems unfathomable! 

Netflix started to slowly overtake traditional movie rentals when it switched to a subscription-based service, eventually becoming a subscription-based streaming service, although surprisingly Netflix does still offer the DVD-by-mail service!

Today, Netflix (NFLX) operates as a subscription-based streaming platform that offers on-demand video, and the vast majority of the company’s revenue comes from these paid subscriptions to one of three plans:

• Basic: This plan allows you to watch Netflix on one device at a time. This plan grants access to all of Netflix’s shows for a monthly fee of $8.99 in the USA and has the lowest video quality (480p) compared to other plans. 
• Standard: This plan grants you access to all of Netflix’s shows, which you can stream and download at any time. The fee for the standard plan is $13.99 and provides better resolution compared to the basic plan. When you subscribe to the standard plan, you can stream Netflix on two devices simultaneously.
• Premium: A premium Netflix plan gives the best video quality at 4K+HDR. When you subscribe to the premium plan, you have access to all of Netflix’s shows, which you can watch on four different devices at a time. 

The business model is clear: invest heavily in content now and reap the rewards of sticky users over the long-term. The J-curve of investment is deep. Netflix must pay billions of dollars annually to create original content. But the fruits of these investments are evident in the lack of customer churn. In short, once customers sign up to Netflix they rarely ever leave. So content costs upfront pay dividends almost ad infinitum.

Netflix Growth Drivers   

Analysts expect Netflix’s revenue will rise 19% to $29.7 billion in 2021, then an additional 15% next year to $34.2 billion. So, what’s driving this growth?

Netflix is winning the streaming wars, surpassing all other streaming service competitors. Getting this size of market share is in large part attributed to its growth drivers. 

Netflix’s biggest growth driver is the fact that the company is focused on offering so much more than a mere streaming service. Netflix’s offerings can be summed up into three categories:

Netflix As a Platform 

As a platform, Netflix’s goal is to deliver the very best user experience possible. 

What sets the company apart from its competitors is the implementation of an intelligent algorithm that suggests shows to its subscribers based on their previous viewing preferences. By using machine learning, Netflix can make practical suggestions to users. This suggestion, in turn, creates better conversion and brand loyalty. This strategy is one way Netflix’s valuation has risen so high.

More recently, Netflix deployed another feature to help drive growth. “Play Something” is similar to ‘shuffle’ on iPods ( and now, music streaming services). Netflix touts Play Something as a button to let Netflix ‘do all the work for you,’ as it chooses a show it thinks you will like based on AI and machine learning when you just can’t decide what to watch.  

Netflix As a Streamer 

Netflix keeps streamers happy by delivering crisp, high-definition video thanks to cloud storage for maximum storage capacity and the highest quality streams with the lowest costs for bandwidth.

This gives users a high-quality HD experience while also presenting barriers to entry for smaller competitors that don’t have the resources to offer the infrastructure to store and deliver such large quantities of content.

Netflix As a Content Creator

Netflix aims to be much more than just a streaming service and/or platform. To accomplish this, Netflix creates original content, including series, mini-series, and even Oscar-winning films.

On its mission to create the first global TV service in the world, Netflix has set up production facilities in London, Toronto, Seoul, Madrid, and most recently, a brand new 170,000 square foot facility in New York.

Management forecasts spending $13.60 billion in total content costs in 2021, with $5.21 billion of that for originals. That’s an increase of 26% on content spend.

As a content creator, Netflix has truly revolutionized the industry as it continues to re-invest heavily in new and original content. The key to its growth strategy is the production of an extremely diversified content portfolio with a focus on unscripted shows and international expansion into the Latin American and Asia Pacific regions.

This means that even if U.S. growth has plateaued, the company’s renewed focus on unscripted shows and international expansion will drive at least a few more years of high growth.

Positive Free Cash Flow

Netflix’s strong subscriber growth during the Covid-19 pandemic paved the way for the company to turn from a cash-burn company to break-even status, and in the Q3 earnings call, Netflix executives reiterated their guidance for positive cash flow in Q4.

Even though Netflix is one of the biggest spenders when it comes to content, its turn to profitability has sustained some bullishness among analysts, and investors. In the third quarter, Netflix’s net content assets totaled $28.97 billion.

Netflix Gaming  

Staying true to its promise of offering a broad portfolio, Netflix has also ventured into the mobile gaming front.

In July 2021, Netflix announced it would implement a new gaming-centric strategy, complete with the November 2021 launch of Netflix Gaming. At launch time, Netflix Gaming subscribers can play five mobile games:

1. Stranger Things: 1984 (BonusXP)
2. Stranger Things 3: The Game (BonusXP)
3. Shooting Hoops (Frosty Pop)
4. Card Blast (Amuzo & Rogue Games)
5. Teeter Up (Frosty Pop)

These launches are just the beginning of Netflix’s plans to build a “library of games that offers something for everyone.”

Here’s how Netflix plans to roll out its worldwide gaming platform:

• Level 1: All you need is a normal Netflix subscription for ad-free gaming.
• Level 2: Take your games on the go with Android devices.
• Level 3: Players around the world can play games offered in multiple languages. The games will automatically default to the language preference set in your Netflix profile.
• Level 4: Members will be able to play games on multiple devices under the same account. Once the device limit is reached, Netflix will alert users so they can sign out of devices that are not in use.
• Level 5: Adults-only games that won’t be available on Netflix Kids profiles. These games will require the same PIN that’s required to access your other adult Netflix profiles.
• Level 6: Game without limits with offline gaming. No wifi required.
• Level 7: Similar to how Netflix offers shows and movies for all kinds of people, they want to offer a brand range of games for beginners to diehard gamers.

The mobile gaming industry is a lucrative market, valued at $173 billion as of 2020. The gaming market is expected to reach $314 billion in 2026. This exponential growth can be mainly attributed to the effects of the pandemic, with more people staying home and turning to video games to pass the time. 

To add value to playing video games on the Netflix platform, the company promises an ad-free gaming experience. The company also pledged to eliminate the need for in-app purchases that players experienced while playing the games on other platforms. 

With its venture into the gaming industry, the company is expected to grow as more viewers subscribe to the platform. In addition to diversifying its content offerings, the company plans to capitalize on culturally relevant shows, as shown in the global successes of Squid” Game and La Casa de Papel. 

Netflix Revenue Growth

Netflix added 4.4 million new subscribers in Q3 of 2021 for a total of 214 million paid subscribers. This topped the company’s modest projections of a net subscriber add of 3.5 million. Take a look at recent Netflix revenue growth year-over-year:

• 2020: 24.0%
• 2019: 27.6%
• 2018: 35.1%
• 2017: 32.4%
• 2016: 30.6%

Q3’s figures put Netflix at a revenue growth percentage of 16.3% — that’s well below the revenue growth of years past, as illustrated above. Netflix expects to add another 8.4 million subscribers in Q4, bringing the total of new subscribers to 18.26 million, a sharp drop from the 36.5 million new subscribers in 2020.

“The big picture is, no one’s really sure,” Netflix co-CEO Reed Hastings said. “You can’t come off the craziness of COVID and be confident of the next two years. So we’re going to push really hard.”

Hastings said Netflix’s goal is to try and return to average subscriber growth of 27 million per year — the average of where it’s been in recent years.

The company also plans to add new metrics to measure viewership. In a letter addressed to its stakeholders, Netflix announced it will now report hours viewed instead of the number of accounts that watched. This new metric will help the company compare viewing time in the same its rivals measure TV viewing. 

Netflix Earnings Growth

Netflix posted sharply higher earnings for Q3 thanks to a strong slate of titles, including Squid Game — a mind-boggling 142 million accounts streamed at least the first two minutes of the hit show in its first month. A set of leaked internal documents showed that Squid Game, which cost $21 million to make, is now worth at least $891 million.

In the third quarter, the company was able to ramp up production and rebound from pandemic-induced delays in the first two quarters of the year.

In all, Netflix’s subscriber base grew 9% from 2020, to 213.6 million — a figure that surpassed the company’s own projections. In the third quarter of 2021, Netflix reported earnings of $1.45 billion, or $3.19 per share — up from $789.9 million or $1.79 per share in the third quarter of 2020.

Netflix’s revenue grew 16% from $6.44 billion to $7.48 billion, and the company expects to add 8.5 million net subscribers in Q4 of 2021. 

Netflix Competitors

Netflix is winning the streaming wars, for now. As more and more subscription-based streaming services emerge, Netflix will find itself facing stiffer competition, including from:

Disney +

Disney + launched in 2019 and like most other Disney products, it’s been quite a success and has risen to be the most prominent Netflix competitor.

Disney+ offers streamers a wide selection of Disney classics, shows, documentaries, and shorts, as well as content from Star Wars, Marvel, Pixar, and National Geographic.

Disney + even offers Fox cult classics, like The Simpsons, after acquiring Fox in 2019. Disney+ is also less expensive than Netflix, at $6.99 per month, or $69.99 per year.

Amazon Prime Video

Amazon Prime is Netflix’s closest competitor in terms of content, offerings, and business model.

Launched in 2006, Amazon Prime Video is included with a regular  Amazon Prime subscription and allows users to stream movies and TV shows included in the subscription.

Subscribers can also rent or purchase movies not included in the Prime Video subscription. Like Netflix, Amazon also produces its own content called ‘Amazon Originals’ and also has subtitles and dubbing in different languages. 

Currently, Amazon Prime video is available to stream in more than 200 countries and territories. 

Hulu

Hulu is a video streaming service owned by the Disney Company and NBC Universal holding a minority stake. Currently, Hulu subscriptions are only available in the United States. 

Hulu works by providing access to shows on major networks and cable TV after they air. Like Amazon Prime Video and Netflix, it also hosts originals like The Handmaid’s Tale. It also has exclusive rights to stream FX (a streaming service owned by Disney).

HBO Now

HBO Now started in 2014 and is owned by the HBO network. Like Netflix, HBO Now offers various movies and series.

Subscribers can watch the content on their smart TVs, phones, desktops, and tablets. However, subscription to HBO Now is only limited to the United States.

Apple TV Plus

Apple TV Plus started in 2019, and unlike its competitors, this streaming service offers almost all original content. It signed up a strong lineup of Hollywood directors, writers, and actors to create new shows and movies. The service is aggressive in its pricing, at only $4.99 a month, shareable for up to six people.

However, it’s worthwhile to note that streaming-only represents 27% of US screen time, compared to 63% for linear TV, according to a Nielsen study.

Netflix accounts only for 7% of US TV screen time in the same survey, leaving a long runway for growth. Netflix aims to improve its service and content and retain its lead in the cutthroat streaming business. 

Netflix International Growth

Netflix has high hopes for international growth. The company started in the U.S. before expanding internationally to 50 countries in 2015. Today, Netflix is available in more than 190 countries, and 138 million of its 213 million subscribers come from countries outside of the United States.

After North America, the EMEA (Europe, the Middle East, and Africa) is the second-largest region for Netflix with 70 million subscribers, followed by Latin America (39 million). The Asia Pacific region is Netflix’s tiniest but mightiest (fastest-growing) market.

Netflix’s international growth is remarkable, and its global strategy had to overcome many unique challenges. For one, it must comply with different types of national regulatory restrictions.

Certain countries have limitations on which content can be made available in their market. Netflix’s international subscribers often prefer content produced in their local language rather than having to watch with subtitles or dubbing that does not always translate accurately.

Moreover, Netflix had to secure content deals by region or country. So, taking this into consideration, what variety of strategies did Netflix implement to ensure its foothold in these countries?

Drivers in Netflix’s International Growth

How did Netflix expand to 190 countries in just over seven years? Let’s take a look at the drivers for Netflix’s international growth.

‘Exponential Globalization’

Professor Louis Brennan defines Netflix’s international growth strategy as exponential globalization. Brennan defines it as a “carefully orchestrated cycle of expansion, executed at increasing speed, to an increasing number of countries and customers.”

Netflix did not expand to all countries simultaneously. Instead, it started its international expansion in Canada — a country that is both geographically and culturally close to the United States. Here, the company practiced its global capabilities without being too ‘foreign.’ 

With the success it found in Canada, Netflix used the data it collected and insights it learned from its Northern expansion and proceeded to Phase two, at which time it expanded to more than 50 countries.

The streaming company chose these countries by their degree of shared similarities, potential customers who can afford the service, and the availability of broadband internet. In this phase, Netflix continued its growth while learning about internationalization. It partnered with local stakeholders while gaining a solid subscriber base and revenue.

Netflix then used the information and insights from the first two phases to rapidly expand to 190 countries, allowing it to gain enough knowledge to understand the type of content its audience wants and what type of marketing is effective. 

Globalizing the Content on Netflix

Content is only good if the audience understands it. Netflix understood this and introduced subtitles and dubbing for its shows in several languages.

With its experience in different countries, Netflix started to get a grasp of what type of content its International audiences wanted. Although most stories are universal, the company knew that people in other countries prefer locally made content with a global appeal, with options for dubbing and subtitles in several languages.

This strategy has proven successful based on the success of Lupin, a French mystery thriller, and of course, the recent record-breaking success of Squid Game.

Netflix also actively pursued global licensing to provide content across its market share simultaneously, while tapping into regionally sourced talent, giving producers in these areas an audience for their ideas.

Cost

In some parts of the world, Netflix is extremely affordable, while in others, it’s pretty costly. Let’s take a look at Netflix’s global cost disparities:

• Argentina — Despite a recent price hike across all three Netflix tiers, the cheapest place to have a Netflix subscription is Argentina — the equivalent of about $3.28 USD.
• Australia — Australia is in the top 10 cheapest countries for all three Netflix plans, with the basic plan costing $8.52 USD/month, standard is $12.39 USD/month, and premium is $15.49/month.
• Germany — Germany is one of the most expensive places to have a Netflix account after a recent $1.23 and $2.38 price increase for its standard and premium plans. The standard service now costs €11.99 per month, while the most expensive plan is €15.99.
• Canada — Recent price hikes have made Netflix subscriptions in Canada on the expensive side. Standard plans now cost CAD 16.99, and premium costs CAD 18.99.
• Ireland — Irish Netflix subscribers have access to the largest number of titles, but they pay for it at a cost of €12.99 for standard and €17.99 for premium.

Netflix Discounted Cash Flow

Netflix’s discounted cash flow forecast for five years is $746.29 per share, suggesting it is overvalued to the tune of 8.1%. The ten-year period discounted flow forecast is $800.13 per share overvalued at 16%.

Discounted cash flow (DCF) is a process for valuation that’s used for estimating the attractiveness of an investment determined from its expected future cash flows. DCF analysis wants to answer the question: How much money will you get from this investment over a certain period? How does this investment compare to the money you can make from your other investments?

A DCF financial model computes this by accounting for the time value of money. It works on the assumption that the worth of a dollar invested today is worth more than a dollar invested tomorrow, because it generates interest in that period. 

Making a DCF Analysis

If you want to create a DCF analysis of Netflix, there are certain assumptions you need to make 

• Netflix’ forecasted sales growth and profit margins — its cash flow
• Rate of interest on the initial investment
• The cost of capital and the possible risks to the company’s underlying value (discounted rate).

The more insight you have into Netflix’s financials, the easier it is to do a DCF analysis. 

DCF Analysis Formula

Below is a simplified formula of a DCF Analysis:

DCF = CF₁/(1+r)¹ +CF₂/(1+r)²+….+ CFn/(1 +r)n

Where:

CF = Cash Flow in the period given

r = interest rate /discount rate. It’s the target rate of return on the investment. This number is expressed in decimal form. 

n = the period number

Let’s dissect what the formula means one by one.

Cash Flow (CF)

Cash flow is the net cash payments received in a given time period for owning a stock or security. Cash Flow when you do a DCF analysis is known as unlevered free cash flow.

Discount Rate

The discount rate for the valuation of Netflix is the company’s Weighted Average Cost of Capital (WACC). The WACC is used because it’s the required rate of return investors will usually expect when they invest in a company.

Time (n)

Each cash flow goes with a period. In computing DCF, you can use months, quarters, or years. You can use a similar time, or if you choose to use different periods, you can express them in percentages of a year.

It’s worthwhile to note that the formula we discussed above is merely a simplified version of the DCF formula so that you can understand the factors involved. With so many variables involved, it can be challenging to get a company’s valuation. That’s why investors choose to use other models of valuation in addition to DCF to make their decision. If you want to check Netflix’s DCF value, you can choose to use the formula, or click here.

Should You Purchase a Netflix Stock with its Current Valuation?

Netflix as a streaming service certainly earned its spot as the preferred streaming service company worldwide. Its presence in over 190 countries in less than ten years is certainly impressive. But should you buy Netflix stock? We’ve covered Netflix valuation, including its history, competitors, growth, earnings, as well as a discounted cash flow forecast. At the time of research, the company appears slightly overvalued but with such a strong moat of technology and content supporting it, Netflix is a solid company to buy on the dip.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.