Netflix (NFLX) is a company that, when it comes to valuation, seems expensive on nearly every metric. Just look at the stats: two-year forward P/E at 43, two-year forward price-to-sales of almost 4, two-year forward EV/EBITDA at 22. They don't just look expensive, they look astronomically expensive. However, what if there was an analysis that suggested NFLX was a bargain at these prices? What if they represented an opportunity to own a disrupter that has even more potential than Tesla (TSLA)?
Let's look at the growth rates analyst are expecting two years out: nearly 72% EPS growth, 18% revenue growth, 51% EBITDA growth. These monster numbers make NFLX look cheap. Look at the two-year forward PEG ratio of 0.60, the two-year price-to-revenue growth at 0.23. What should NFLX be worth? Challenging to value a company that's destroying the landscape of the entire media industry and engraining itself into everyday life, isn't it?
Destroying the media landscape? Engraining itself into daily life? In addition, it aspires to disrupt the movie theater business as well.
(Movie Ticket Data From Box Office Mojo, Numbers In Billions)
If you notice in the chart above, sales of movie tickets peaked around 2001-2002 and have been steadily declining since then. In fact, since NFLX introduced its streaming services nearly 10 years ago, in 2007, movie ticket sales have continued to decline steadily. You could blame surging ticket prices, but that's not likely the exact reason for the decline.
(Movie Ticket Data From Box Office Mojo, Tickets Sold In Billions)
The chart above should quickly dismiss rising ticket prices as a reason for declining theater attendance. As one can see above ticket prices increased steadily until 2010, before leveling off. In fact, 2010 was the year that NFLX crossed over 20 million subscribers mark. Let's look at NFLX's domestic subscriber growth compared to movie ticket sales.
(Movie Ticket Data From Box Office Mojo, NFLX Subs Data from NFLX 10-K's)
Despite stable movie ticket prices, the slowdown in tickets sales has continued even as NFLX's domestic streaming subscriber base grows. This implies that people are choosing to stay home and watch movies via a streaming subscription instead of going out to the movies.
The Future Will Stream
NFLX is spending tons of money to develop its content for viewers to watch on demand. In 2017, the company is planning to invest $6 billion in content. So how is NFLX destroying the media landscape? Just look at the unbundling that is disrupting in the cable industry. Consumers have more options to choose how to get content at a fraction of the price they used to pay. Comcast's (CMCSA) most recent 10-K disclosed that the company's video household customer base was flat in the 2014-2016 period, going from 22.4 million to 22.3 million, to 22.5 million.
Over time, the second- and third-order impacts of cord cutting will be profound. When people consume less cable content, the price of the cable bundle falls, which in turn means the content creators get less money. Cable companies will live on as providers of internet data connections. However, traditional media will have to transition to all streaming platforms, to accommodate changing consumer habits. TV time slots and program schedules will likely disappear. These changes will affect the revenue models of many other companies as advertising metrics begin to shift. Amazon (AMZN) and the Hulu joint venture are the other major players in the space, but there's plenty of room for more competition.
The On-Demand Generation is growing up at a time when getting content has never been easier. Members of the younger generation don't understanding what a commercial break is or grasp what it means to wait a week to see their favorite show. They just turn on the TV, switch on NFLX and quickly find whatever it is they want to watch. No waiting, don't like a program? Switch to something else. Love one show, watch it as many times as you like. (See also: The On-Demand Generation Will Forever Change Media.)
NFLX is being integrated into daily life, which is perhaps the most important point of all. It's like Apple (AAPL) and the iPhone. Remember, Apple came along with the iPhone in 2007, when Blackberry (BBRY) was the most dominant phone maker. Blackberry is almost a memory and Apple is now among the biggest public companies in the world. This is all because it created a relatively easy-to-use product that had style and was an improvement over existing technology, and then built and ecosystem. NFLX follows a very similar trajectory: it launched a distribution platform, it licensed content and now it's creating its own shows and movies. In a word, it has created an ecosystem: if you want to watch a Netflix original show, Netflix is the only place to see it.
The amazing part is that we haven't even gotten to the international segment and growth potential. NFLX had nearly 45 million international users at the end of 2016, in a world of 8 billion people. According to Eurostat, there are approximately 219 million households in Europe. According to Statita, there are nearly 165 million households in Latin America. According to the government of India, there are approximately 250 million households in India as of 2011. In these three regions alone, the size and scope of the potential user base is gigantic. NFLX 45 million international subscribers only represent 7% of these three regions total of 650 million households. This gives a sense of how much growth potential there is on the international stage.
How do you value NFLX? Good luck with that. It's nearly impossible to value a company like NFLX. You can make assumptions about growth rates, penetration rates or cash flows, but this is a business that is shifting the way everyone thinks about media. It is changing people's basic habits. Ask a six year old to chose their favorite show on NBC, CBS or ABC. Then ask them about their favorite show on Netflix. You can't value that answer.
Michael Kramer and the clients of Mott Capital Management, LLC own shares of NFLX and TSLA. Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request the advisor will provide a list of all recommendation made during the past twelve months. Past performance is not indicative of future performance.