Netflix’s shares jumped over 15% after reported third-quarter earnings last week. The streaming company posted better-than-expected top and bottom-line results, as well as an addition of 2.41 million net global subscribers, more than double the adds projected a year ago.
In its letter to shareholders, Netflix also announced that it was no longer going to report its paid membership numbers, as it explores the development of new revenue streams like advertising and paid sharing. The streaming giant will be launching a new ad-supported subscription plan in North America and Europe starting in November this year. The plan will be 20-40% below the current starting price, will have ~5 mins of advertising per hour, frequency capping and strong privacy protections. The company believes that this plan will target more price-conscious consumers and translate into meaningful incremental revenue and operating profit over time.
Netflix also took the opportunity to reiterate to shareholders that there is still much room for growth ahead. Netflix said that its current annual revenue of $30 billion only accounts for 5% of the combined market size of the industries it plans to compete in. This amounts to a ~$300 million pay TV/streaming industry, ~$180 billion branded advertising market and ~$130 billion gaming industry (excluding hardware sales). As it is becoming increasingly evident that streaming is the future of entertainment, Netflix’s competitors, including media companies and tech players are investing billions of dollars to scale their streaming services.
Having an already established streaming platform with a wide subscriber base, Netflix has instead focused on building up its library of streaming content, anticipating that some competitors would eventually stop licensing their content to Netflix. The company has released a lineup of popular titles including Stranger Things S4 (1.35 billion hours viewed), Monster: The Jeffrey Dahmer Story (824 million hours viewed), and The Sandman (351 million hours viewed). Netflix has also experienced success in foreign language series, with Squid Game becoming the first foreign language to win an Emmy. Other popular Korean series include Extraordinary Attorney Woo (402 million hours viewed) and Narco-Saints (128 million hours viewed).
Cash flow
Net cash generated from operating activities in Q3 increased from $82 million in 2021 to $557 million in 2022. Free Cash Flow also swung back to +$472 million this year, compared to -$106 million in Q3’21. Netflix expects a FCF of $1 billion for the full year of 2022 and substantial growth of FCF in 2023 assuming no further material appreciation of the US Dollar.
Valuation and assumptions
Analysts’ projection for Netflix’s Free Cash Flow is around $1 billion annually. Based on a 5-Year Discounted Cash Flow Model and FCF projections, Netflix’s intrinsic value is around $95 billion or $218 per share. This model uses a conservative discount rate of 10% and a terminal P/CF multiple of 25.0x. Given that Netflix is currently trading at $282 per share, its intrinsic value represents a 23% downside from current prices.
5 Year DCF Model of NFLX
Investment recommendation and verdict
Netflix’s share price is slightly overvalued based on my DCF model and hence not an attractive stock to buy at current levels. While the company claims that there is much room for growth ahead, the path to success will not be easy as it faces increasing competition and short-term macroeconomic headwinds. Therefore, I would give Netlfix a hold rating with a price target of $218 per share.
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