What Justifies A $445 Price Estimate For Netflix?

Netflix’s (NASDAQ:NFLX) stock has seen a gradual run-up this year, and is currently trading at around $440 level whereas our $315 price estimate for the company stands at a discount of about 30% to the market. This begs the question – what does the current market price represent in terms of Netflix’s future growth? In this analysis, we try to answer this question by looking at certain fundamental business and valuation drivers that have high levels of uncertainty associated with them. We find that in order to justify a market price of $445, Netflix will have to accelerate its profit growth in international markets, resort to further price increases and demonstrate business stability.

See our complete analysis for Netflix

Higher Growth In Average Revenue Per Subscriber And Margins In The U.S. (+$50)

While Netflix’s subscriber growth in the U.S. is as good as it is going to be, there exists upside potential from higher growth in average monthly revenue per subscriber. Currently, this figure is at around $7.60 and we expect it to reach close to $8.80 by the end of our forecast period due to the recent price hike. However, as the company’s customer base and content library grows, it will have an opportunity to further increase subscription prices. It can also increase average revenue per user by resorting to differential pricing catering to individuals at home and customizing content according to their preferences. If such opportunities arise and if Netflix is able to increase its average monthly fee per subscriber to $10, it will add roughly $35 to our price estimate. However, the impact will trickle down to profits and margins could rise to 40% in such a scenario. This will add another $20.

Acceleration In International Profitability (+$35)

Netflix’s international operations are still unprofitable as the company continues to invest heavily in European expansion. Going forward, Netflix’s international expansion could have a significant impact on both its subscriber additions as well as contribution margins. In September 2014, Netflix launched its service in Germany, France, Austria, Switzerland, Belgium, and Luxembourg. This expansion could push its quarterly net additions to as high as 2 million, but would lead to a negative impact on profits in the short term. However, given that Netflix’s current international operations are nearing profitability, it makes sense for the company to take some risk and consolidate its position in the international markets. Nevertheless, if Netflix has to justify its current market valuation, it will need to accelerate international contribution margins. We currently forecast this metric to increase from -34.5% in 2013 to little over 32% by the end of our forecast period. However, if this figure reaches 40% within the same time frame, it will add $35 to our current price estimate.

Lower Weighted Average Cost Of Capital (+$45)

We currently use discount rate (or weighted average cost of capital) of 11% for valuing Netflix’s stock. This is the rate at which we discount the company’s future cash flows, and is the weighted average of its after-tax cost of debt and cost of equity. This figure is a measure of a company’s risk. We believe that in order to justify a market price of $450, Netflix will have to lower its risk such that WACC (weighted average cost of capital) comes down to 10%. The only way this can happen is when the company’s Beta declines. Beta is a measure of company’s stock movement relative to broader market movement. Netflix’s price has fluctuated a lot in the past, which implies higher Beta or a higher level of risk. If Beta has to come down, Netflix will need to demonstrate stable profit growth and customer loyalty.

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