To The Moon

$Netflix(NFLX)$ stock rallied over 7% after the company reported that it lost fewer subscribers than anticipated during the second quarter. Netflix had warned investors that it expected to lose 2 million subscribers last quarter but only lost reported a 970,000 subsriber loss this quarter. The company also announced that it was partnering with $Microsoft(MSFT)$ to roll out a lower-cost ad-supported tier in 2023. While I believe that Netflix is taking the right steps to revive its business model, I feel that in the current macroeconomic environment, Netflix is not a good investment as it is too expensive compared to the free cash flow it generates.

Key Financial Highlights

Revenue in Q2 grew 9% year over year or 13% excluding foreign currency impact. The strong US dollar presents a headwind to Netflix along with other US companies which derive their revenues outside of the US. Furthermore, Netflix is projecting a 4.7% revenue growth in Q3 which is considerably lower than the mid-teens growth rate it has been growing at the past few years.

Free Cash Flow for the quarter was mildly positive ($13 mn) and expected to grow to $1 bn for the full year of 2022. Netflix’s FCF track record has been spotty in the past, but the company is expected growth going forward due to “increasing revenue, solid profitability, and the successful multi-year evolution of our content model.” Netflix also claimed that it is past the most cash intensive part of its transition to original content production and expects cash spending on content to decline going forward. While Netflix currently boasts a strong line-up of titles including Stranger Things, Ozark and Squid Game, it remains to be seen if new content is needed to continue attracting audiences to renew their subscriptions.

Netflix’s regional breakdown shows that the company lost subscribers in North America (UCAN) and Europe (EMEA) regions while growing in Asia (APAC). Currently, Nort America and Europe have a larger average revenue per membership than Asia and it is not a good sign that Netflix is losing subscribers in the highest-paying regions.

Growth catalysts

In the recent months, Netflix’s growth rate has been lagging its competitors. Therefore, a key priority for the company is to re-accelerate revenue growth and improve monetisation. It plans to launch a lower priced advertising-supported plan to users in 2023 which the company says can enable substantial incremental members and profit growth in the long run. It also aims to find ways to monetise viewership among shared accounts and is exploring paid sharing services which it can roll out in 2023.

Investment Thesis and Valuation

Netflix’s market cap is currently $100 bn which is 100x 2022’s expected FCF. From a FCF perspective, we can see that Netflix is still highly overvalued with a FCF yield of 1%. In the current macroeconomic situation where inflation remains elevated, highly valued companies tend to perform the worst while companies with strong FCF will outperform. Given Netflix’s rich valuation and the fact that revenue growth has slowed recently, I do not see Netflix as an attractive investment. To me, a reasonable valuation for Netflix would be 20x FCF which at current FCF levels would mean a share price of $45. For me to invest in the company, I would need to see huge FCF growth which I doubt Netflix can achieve simply by introducing advertisements and paid sharing models. Therefore, despite Netflix’s recent financial results and upcoming plans, I remain bearish on the company.

Disclaimer: This article is meant solely for informational and educational purposes and does not constitute investment advice. Perform your own due diligence before making any financial decisions.

@TigerStars@CaptainTiger@TigerEvents@Daily_Discussion