Why We Believe Netflix Stock Is Worth $103

Netflix (NASDAQ:NFLX) posted strong numbers in its Q2 2015 earnings announced on July 15th, and the stock has jumped 15% since then. The company has reported strong subscriber numbers in the last three quarters after an unexpected miss in Q3 2014, and its global subscriber base currently stands at 65.6 million. Our take on Netflix is that its overall subscriber base will continue to grow in the coming years but the rate of growth in domestic subscribers is likely to come down due to increased competition and potential market saturation. On the other hand, international subscriber growth will remain robust in the near future as the company expands into various new territories with the aim of having a presence in 200 countries by the end of 2016. Netflix’s domestic margins continue to improve but the international expansion is hurting its international margins, which continue to remain negative. However, we expect the international segment to break even by 2017 and to have a positive contribution margin 2018 onward. Consequently, we are revising our price estimate for Netflix to $103 based on the following projections.

See our complete analysis for Netflix

Domestic Subscribers Will Grow to 62 Million By 2022

Netflix’s domestic subscriber base crossed the 40 million mark this year and is still growing at a steady pace, having added 3.18 million new subscribers during the first six months of 2015. ^[1] Netflix will face increased competition in the coming years as evidenced by the recent crowding of the online streaming market. Content providers such as Dish Network (NASDAQ:DISH), Sony (NYSE:SNE), Apple (NASDAQ:AAPL) HBO, CBS (NYSE:CBS), and Comcast (NASDAQ:CMCSA) are some of the players who have either launched their own streaming service recently or are planning to launch soon. However, we believe that the company will be able to hold its own among the competition. The success of Netflix’s original content has improved viewers’ perception of the overall brand. The company is no longer considered just an aggregator of popular content from other networks and has come of age as a provider of engaging and interesting content of its own. Netflix also tends to be viewed as a complementary service rather than a competing service to various pay-TV operators. End users could potentially form the same opinion of the company when it is compared to other streaming services in the future. Additionally, Netflix’s service functions more like a repository and users can access much older content which might not be readily available on other streaming services. Consequently, we believe that Netflix’s domestic users will be just shy of 62 million by 2022.

Domestic Contribution Margins Will Cross 40% By 2020

Another area that Netflix is rapidly improving is the contribution margin for its domestic streaming segment. This margin has improved from 14.3% in 2011 to around 30% in 2014. ^[2] Netflix’s domestic streaming margin has continued its upward climb in 2015 and currently stands at 33.1% as of Q2 2015. ^[1] The company had earlier stated that it intends to improve domestic streaming margins by 200 bps/year but now believes that it can improve even further as a larger portion of global and original content costs will now be absorbed by the company’s ever growing international territories. ^[3] The company intends to cross the 40% threshold by 2020, a target we believe to be achievable.

Netflix Will Have 68 Million International Subscribers Within Next 6-7 Years

Netflix’s international operations are still unprofitable as the company continues to invest heavily in its expansion. The company is currently present in around 50 countries and intends to expand into 200 countries by the end of 2016. Going forward, Netflix’s international expansion could have a significant impact on both its subscriber additions as well as contribution margins. The company launched operations in Western Europe and ANZ (Australia & New Zealand) in September 2014 and March 2015, respectively, giving it access to a combined potential subscriber base of about 74 million broadband households. ^{[4] [3]} The company is also poised to launch into Japan, Spain, Italy and Portugal later this fall. (Related – A Closer Look At Netflix’s Foray Into Japan) There have also been reports of Netflix entering India in 2016. (Related – With Eye On the Future, Netflix Could Enter India In 2016) China, Japan and South Korea are some other territories with fast Internet service that Netflix could venture into later. The company is very keen on entering the Chinese market and is exploring potential routes for entry. (Related – China Makes Sense For Netflix, But It Won’t Be Easy) Subscriber growth in the international segment has been very robust so far, with the subscriber base increasing from 1.9 million customers in 2011 to 23.3 million by the end of Q2 2015. ^[2] We believe that Netflix can reach 68 million international subscribers by the end of our forecast period if it continues on its current expansion plans.

International Contribution Margins Will Break Even By 2017

The markets that Netflix launched into prior to 2014 (Canada, Latin America, the UK, Ireland, the Nordic countries and the Netherlands) became profitable on a contribution basis in Q3 2014 and continue to grow. ^[5] The company acknowledges that the progress has been so strong that it now believes it can complete its global expansion over the next two years while managing to still be profitable. This is possible as Netflix will start experiencing operational efficiencies as it grows operations in the target countries. The marketing expenses will also come down as a percent of sales once the company establishes itself in these countries. We believe that Netflix’s international segment will break even by 2017 and will have a positive contribution margin 2018 onward. It will then stabilize at around 30% by the end of our forecast period.

Lower Weighted Average Cost Of Capital

We have revised our discount rate (or weighted average cost of capital) downwards 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. Netflix justifies this revision as the stock’s beta has come down in the past year. Beta is a measure of the company’s stock volatility relative to the broader market. Netflix’s correlation to the broader market has improved, which means that the risk of fluctuations in its stock price has come down. The company has also been able to stabilize its business and increase its revenues without taking on substantial debt. Netflix’s total long term debt currently stands at $2.4 billion, which is significantly less than the company’s enterprise value of $48.31 billion as of July 17, 2015. ^[6] This reduces the risk in the company and warrants the revision.

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More Trefis Research

1. Q2 15 Letter to shareholders, Netflix Investor Relations [↩] [↩]
2. Netflix’s SEC Filings [↩] [↩]
3. Q1 15 Letter to shareholders, Netflix Investor Relations [↩] [↩]
4. Q3 14 Letter to shareholders, Netflix Investor Relations [↩]
5. Q4 14 Letter to shareholders, Netflix Investor Relations [↩]
6. Netflix Enterprise Value, YCHARTS [↩]