Opinion: This math shows why Netflix’s stock price could dive to $121
With the loss of subscribers in Q1 2022 and expectations of further deterioration in subscribers in Q2, the weaknesses in Netflix’s business model are undeniable, as we have pointed out for years.
Even after falling 67% from its 52-week high, 56% from our April 2021 report, and 39% since our January 2022 report, we believe NFLX stock,
could drop another 50%.
Strong competition is taking market share, limiting pricing power, and making it clear that Netflix can’t generate anything close to the growth and earnings that the current stock price implies.
Netflix lost 200,000 subscribers in the first quarter, the company’s first loss of subscribers in 10 years. More alarmingly, management guided a further loss of 2 million subscribers in the second quarter.
We expect subscriber contraction to be the moving norm as more competitors bolster their offerings and deep-pocketed peers such as Disney DIS,
continue to invest heavily in streaming.
Indeed, Netflix faces a litany of challenges in turning its cash-generating business into a revenue-generating business and justifying the expectations embedded in its stock price.
A huge red flag
Netflix’s free cash flow was positive in 2020 for the first time since 2010. But the positive FCF came almost entirely from Netflix’s reduced content spending during the COVID-19 pandemic. Netflix cannot generate positive FCF and increase content spend.
In the past, we’ve seen a strong relationship between content spend and subscriber growth. So the expense seemed worth it. Since Tuesday’s earnings release, we’ve seen that relationship break down.
According to this graph, even after a significant increase in content spending in 2021 and in the past 12 months, or TTM, Netflix’s subscriber growth continued to decline year over year. Given the hyper-competitive, content-driven nature of the streaming business, a lack of subscriber growth is a huge red flag. Throwing billions of dollars at content won’t be enough to fend off the competition, and even when you’re spending a lot on content, new subscribers don’t show up.
Meanwhile, Netflix has stayed out of the live sports arena, a stance that is unlikely to change. Yet Disney, Amazon, CBS, NBC and Fox FOX,
(each with their own streaming platform) are getting rights to more and more live content, especially the NFL and NHL, giving them a hugely popular offering that Netflix can’t match. More recently, Apple started streaming Friday Night Baseball and it was reported that Apple was close to closing an NFL Sunday Ticket deal, which would only bolster its live offerings.
Lily: As Netflix haemorrhages subscribers amid increased competition from Disney, Hulu, HBO, Amazon Prime and Apple, have we finally peaked in streaming?
Netflix’s Current Valuation Means Subscribers Will Double
We use our Inverse Discounted Cash Flow (DCF) model and find that expectations for Netflix’s future cash flows seem overly optimistic given the above competitive challenges and indications for further slowing in user growth. To justify the current Netflix stock price of around $240, the company must:
maintain its 5-year average NOPAT margin of 12% and
increase revenue by 13% compounded annually through 2027, which assumes revenue increases by consensus estimates in 2022-23 and 12% each year thereafter (equal to 2022 revenue estimates)
In this scenario, Netflix’s 2027 implied revenue of $59.5 billion is 4.4 times Fox Corp’s TTM revenue, 2.1 times Paramount Global’s TTM revenue, 1.5 times the combined TTM revenue of Paramount Global and Warner Bros. Discovery WBD,
and 82% of Disney’s TTM revenue.
To generate this level of revenue and meet the expectations implied by its stock price, Netflix would need either:
335 million subscribers at an average monthly price of $14.78/sub
424 million subscribers at an average monthly price of $11.67/sub
For reference, Netflix had 222 million subscribers at the end of the first quarter.
This $14.78 represents the average monthly revenue per subscription in the United States and Canada during the quarter. However, the majority of Netflix’s subscriber growth comes from international markets, which generate far less per subscriber. The overall (US and international) average monthly revenue per subscriber was $11.67 in 2021. At that price, Netflix needs to nearly double its subscriber base to over 424 million to justify its stock price.
Netflix’s implied net operating income after taxes, or NOPAT, in this scenario is $7.1 billion in 2027, which would be 3.6 times Fox Corp’s 2019 (pre-pandemic) NOPAT of 1.9 times the 2019 NOPAT of Paramount Global, 1.1 times the combined 2019 NOPAT of Paramount Global and Warner Bros. Discovery, and 67% of Disney’s 2019 NOPAT.
This graph compares Netflix’s implied NOPAT in 2027 with the 2019 NOPAT of other content production companies.
There’s a 50% drop if margins fall to the average of streaming history
If Netflix’s margins fall even further given competitive pressures, increased spending on content creation and/or subscriber acquisition, the downside is even greater. More precisely, if we assume:
Netflix’s NOPAT margin falls to 9% (equal to the average since 2014) and
Netflix grows revenue by 10% annually through 2027 (equal to management-guided annual revenue growth rate for 2Q22)
then the stock is only worth $121 today, a 50% drop.
In this scenario, Netflix’s revenue in 2027 would be $51.3 billion, implying that Netflix has 289 million subscribers at the current average monthly price in the US and Canada or 367 million income subscribers overall average per subscriber of $11.67/month. Either subscriber number is higher than what Netflix currently has.
In this scenario, Netflix’s implied revenue of $51.3 billion is 3.8 times Fox Corp’s TTM revenue, 1.8 times Paramount Global’s TTM revenue, 1.3 times Paramount Global’s combined TTM revenue and Warner Bros. Discovery and 70% of Disney’s TTM revenue. revenue.
Netflix’s implied NOPAT in this scenario would be 2.3 times Fox Corp’s 2019 NOPAT (pre-pandemic), 1.2 times Paramount Global’s 2019 NOPAT, 70% Paramount Global and Warner Bros. Discovery’s combined 2019 NOPAT, and 43 % of Disney’s 2019 NOPAT. .
This chart compares the company’s historical revenue and implied NOPAT for the scenarios above to illustrate the expectations embedded in Netflix’s stock price. For reference, we also include the pre-pandemic NOPAT from Paramount Global and Warner Bros. Discovery.
Still too optimistic?
The scenarios above assume that the year-over-year change in Netflix’s invested capital is 14% of revenue (half of 2021) for each year in our DCF model. For context, Netflix’s invested capital has grown by 40% per year since 2014 and the change in invested capital has averaged 26% of revenue each year since 2014.
It is more likely that spending will need to be much higher to achieve the growth in the above forecast, but we use this lower assumption to highlight the risk in the valuation of this stock.
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David Trainer is the CEO of New Constructs, an independent equity research firm that uses machine learning and natural language processing to analyze company filings and model economic profits. Kyle Guske II and Matt Shuler are investment analysts at New Constructs. They receive no compensation for writing about a specific title, style or theme. New Constructs does not perform any investment banking function and does not operate a trading desk. Follow them on Twitter @NewConstructs. This is an abbreviated version of “Netflix could fall another 50%” published on April 20.
David Trainer, Kyle Guske II and Matt Shuler