To The Moon

1. $Netflix(NFLX)$Netflix share price has tanked 40% since the start of the year, and that’s just a span of 3 weeks. The reasons were a mix of the macro environment (interest rate rising causing a valuation reset) and Netflix’s earnings guidance for the next quarter.

2. The latest earnings per share of $1.33 crushed consensus estimates of just $0.82, while revenue of $7.71b was in line with expectation. Netflix added 8.3m customers in the past quarter but the projection for Jan-Mar 2022 was a low 2.5m. That is even less than the 5.9m forecast by analysts. Netflix share price tanked 20% on that faithful day the guidance was given.

3. It should be obvious by now that the positive effect of the pandemic - putting people at home and they have nothing to do so they subscribe and watch Netflix - is wearing off. Majority of the countries have decided to live with Covid even though Omicron is a more contagious variant. As such, people are getting out rather than staying home with Netflix. Hastings has also cited the growth in Latin America is slowing as the economy is struggling to recover from the pandemic and it has affected the demand for the streaming service.

4. With such a big drop in the share price for a famous company, some investors will naturally eyeball it as an opportunity to buy it at an attractive price, provided that this is a temporary setback. Let me share my view on this.

5. Firstly, Netflix’s revenue growth rate has been slowing every year since 2018.

2017 +32.4%

2018 +35.1%

2019 +27.6%

2020 +24.0%

2021 +18.8%

6. It is normal that new customers are increasingly difficult to get once you have a large customer base. Every company will become a victim of its own success at some point - the easier customers were gained and now more persuasion is needed to attract yet-to-be customers (they would have been customers already if they didn’t need more convincing.)

7. For my personal case, I watch Netflix but I don’t pay for it. I leech my wife’s subscription. How is Netflix going to persuade me to pay for a separate subscription? The unit economics for Netflix is by the household and not the individual. I would even argue that it could be friends and relatives sharing an account. One way is to up the subscription fee which Netflix has done in a handful of occasions.

8. My super rough estimate is that there are 1.58b households in the world (use average 4.9 pax per household and average is dangerous sometimes) and that includes poorer countries that may not be able to afford Netflix. Let’s just make a blue sky scenario here. Netflix has 222m subscribers currently (14% of total households). That means Netflix still has another 1.36b households to sell to. It is a huge TAM.

9. But Netflix is not the only player in town. Over the years more streaming competitors have come online - Disney+, Amazon Prime Video, Apple TV+, HBO Max, just to name a few. Hence, Netflix’s market share has shrunk but still able to command almost half of the market.

10. Does Netflix have the economic moat to further protect its market share? I would say yes because it benefits from economies of scale. Netflix has commissioned many exclusive content on its platform and many have gone on to win awards, as well as breaking viewership records. The more subscribers Netflix has, the more capital they can get to do more great exclusive content, and in turn retaining current customers and attracting new ones - a virtuous cycle.

11. Streaming non-original content is no longer viable nor attractive. And you need decent budgets to create blockbuster shows. Not half-hearted efforts as seen in Amazon and Apple. This is a personal view though - their selections suck. The only alternative that is attractive to me is Disney+ because of the exclusive Marvel shows. So Netflix has some moat flywheel in this - they have the biggest subscriber base to provide the capital and they have the experience to create great exclusive content. Unless Amazon and Apple are willing to splash capital to fight the streaming war, Netflix is enjoying the advantageous position.

12. But a watch area is that the competition isn’t just against other streamers. It is competing for leisure time and another big space would be games. If someone is playing games, he wouldn’t be watching Netflix and its value proposition declines. Hastings held this view and it is deliberate that Netflix expanded into games.

13. Come on, I don’t even play mobile games and why would I go an extra step to play Netflix games? That said, I think a possible strategy is to create games off their Netflix originals and there is no other places to play the games except on Netflix. Squid Game comes to mind. Make ancillary products to reap maximum benefits out of a hit show. This is what Disney has done very well - merchandise, amusement parks and royalties. Netflix can squeeze more profits out of the same customers instead of just attracting new ones.

14. Next we talk about valuation. Using 5y average price metrics, Netflix is trading below most of them currently. Current PS is 5.6 while average was 9.2. Current PE is 33 while average was 138. PEG ratio is 1.6 vs average of 2.5. Netflix stock price doesn’t look expensive but note the declining growth rate and 5y average may not be a good indication as such (valuation should be higher in the past when the growth was higher).

15. Netflix is a mature stock now and no longer a fast growing one. It is becoming more like Disney and current PS, PE and PEG for Disney are 3.7, 123 and 0.99 respectively. Hence I would think that using PEG ratio less than 1 would make sense for Netflix. If so, a better price would be around $225 or below.

16. That said, Bill Ackman has been a buyer. He just announced his hedge fund has bought up $1b worth of Netflix shares and now a top 20 shareholder of Netflix. Buffett has a good rule of thumb for valuation - it should be obvious to you that it is cheap and you don’t need to do complicated modelling to arrive to the conclusion. Right now, I am not sure if Netflix price is good.