By Ciara Linnane, MarketWatch
MarketWatch photo illustration/Netflix
Michael Nathanson of MoffettNathanson offered an interesting view in a note on Netflix Inc.’s disappointing second-quarter earnings release late Wednesday:
‘To be clear, we think 10 to 15 year DCF [discounted cash flow] models are interesting, but bullshit, and used by the sell side to defend a stock that they want to champion.’
Michael Nathanson, MoffettNathanson
The analyst describes how he and his colleagues have struggled to understand the streaming giant’s equity value, ever since it broke above $100 billion in market capitalization early in 2018 when the stock breached the $200 mark.
At the time, that made Netflix more valuable than Disney /zigman2/quotes/203410047/composite DIS -2.56% and Comcast /zigman2/quotes/209472081/composite CMCSA -0.55% , two well-known owners of hard assets that generate plenty of free cash flow, as he noted. Netflix, in contrast, has posted better-than-expected subscriber numbers in the intervening quarters but higher free-cash-flow losses as it spends heavily on content. Its stock has continued to climb and now trades above $320.
“It wasn’t fun missing out on this spectacular run, but we just couldn’t find a methodology that showed upside to the stock price, even in our most aggressive models,” said Nathanson.
In analyzing Netflix, MoffettNathanson, which bills itself as a next-generation independent sell-side research boutique, treats the U.S. business as a stand-alone “blue sky” asset, and then calculates what the market is implying for the rest of the world. In its most recent analysis, published in June, the firm modeled for 88.4 million subscribers by 2025, domestic revenue per user of $25 and EBITDA margins (earnings before interest, taxes, depreciation and amortization) of 34%.
Using 12 times 2025 EBITDA and an 8% discount rate, the firm estimated that the U.S. present value was $66 billion, meaning the international assets were worth more than $114 billion.
“Of course, looking at this quarter’s results, that ‘blue sky’ scenario looks downright psychedelic as [the second quarter’s] U.S. subscriber adds turned negative on the back of $1 to $2 price hikes and an underwhelming content slate,” he said. “ This one quarter calls into question many of those 2025 endpoints.”
If the company’s third-quarter guidance is accurate, U.S. net subscriber additions are running at 60% the rate of 2018, marking the first year of year-on-year deceleration.
“In other words, the S-Curve in the U.S. may be finally be flattening after all these years of growth,” said the note. “As such, it will increase doubts about Netflix’s final resting subscriber base. Maybe it is 80 million vs. the 88.4 million in our prior valuation case. “
Netflix acknowledged that price increases of $1 to $2 a month had hurt subscriber growth in the quarter, which raises questions about its pricing power, said the MoffettNathanson note. And if the company is losing customers before the streaming market is inundated with new competitors, how will it cope when they are all up and running?
“Will Netflix always need to spend on original content and promotion to hold subscribers in the increasingly competitive U.S.?” asked Nathanson. “We think so. As such, if we assume that the 2025 end point is 80 million subs with $17 RPU and 30% margin, this equates to a current equity value of $35 billion, which implies that the international value is $142 billion, or more than four times (!) the value of the U.S. business.”
Netflix shares were down 11% but have gained 21% in 2019, while the S&P 500 /zigman2/quotes/210599714/realtime SPX +0.0020% has advanced by 19% and the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA -0.19% has risen 17%.