Netflix Full Year 2016 Results & Model Update
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Author: Ross Griffiths, Published: February 27, 2017 at 9:00pm EST, Category: Earnings Review
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Netflix (NASDAQ:NFLX) reported 2016 results that far exceeded management guidance and consensus estimates of membership, revenue and margin growth. Following the announcement I am maintaining a HOLD rating, but raising the target price to $136, based on 10x 2021 earnings and supported by a DCF valuation. Long-term estimates largely remain as at initiation as I don’t believe we have yet seen anything to give us cause for altering long-term trend forecasts. However, consecutive short-term outperformance of management guidance gives cause for further optimism and has the effect of bringing forecast revenue increases forward and boosting the number of subscribers I see the company reaching at the end of our forecast period.
At $136, the base case valuation reflects the confidence felt that Netflix can achieve membership growth approaching the top of management guidance. However, I do not believe at this point in the company’s growth story one can reasonably expect that guidance to be far exceeded, particularly given the fact that we are yet to see a meaningful competitive landscape emerge in the SVOD space. This is reflected in our Bull case valuation which, at $146, does not have a great deal of runway over and above the base case, and is in excess of a 50% premium over the Bear case valuation of $96.
Cash consumption is high and exceeding management estimates. Based on current cash burn trends and aggressive expenditure, debt issues are forecast for Q2 2017 and Q1 2018, though with its currently underleveraged capital structure, the company should not be burdened by increasing its debt. With margin growth exceeding estimates for both domestic and international streaming, I estimate the international streaming business becoming profitable by 2018 and contribution margin growing to approach convergence with domestic streaming by the end of the forecast period. Cost growth has been high and additions to streaming libraries have approached 100% of revenue as at December 2016. The ability to reduce this ratio gradually in line with membership growth underpins the Base case valuation, and as discussed at initiation cash costs and content amortization (P&L content spend) will be monitored closely as the streaming business becomes established globally.
Q4 2016 results reaffirm the perceived wisdom that membership growth is driven by the popularity of originally produced content. Netflix has been successful in producing popular and critically acclaimed content, evidenced by the success of The Crown in winning Best Drama at the 2016 Golden Globes. Management and analysts are in agreement that high quality original content is a key driver of subscriber growth and retention, and signs are strong on the content front with much-hyped new releases such as The Crown and Gilmore Girls proving popular internationally in Q4, following previous strong viewing numbers for shows such as Luke Cage, and Narcos.
Longer-term, I believe the threats covered in the initiation report remain, but the company is showing encouraging signs of capitalising on its first-mover advantage in the SVOD space to build a strong and resilient enough base to cope. We are yet to see the emergence of meaningful competition but re-emphasise the expected global expansion of Amazon Instant Video (part of the Amazon Prime package) following the release of flagship programme The Grand Tour in over 200 countries in 2016. Domestically, Net Neutrality legislation should be monitored, but there is not currently strong enough evidence to suggest regulations to impede net neutrality will be introduced.
Valuation Risks
The Base case price target of $136 is predicated on 1) Subscriber growth estimates, 2) Ability to reduce content costs, particularly relative to revenue, 3) Increases in revenue per user driven by forecast subscription price increases, 4) Management of cash consumption over the next 18-24 months.
At $136, the base case valuation reflects the confidence felt that Netflix can achieve membership growth approaching the top of management guidance. However, I do not believe at this point in the company’s growth story one can reasonably expect that guidance to be far exceeded, particularly given the fact that we are yet to see a meaningful competitive landscape emerge in the SVOD space. This is reflected in our Bull case valuation which, at $146, does not have a great deal of runway over and above the base case, and is in excess of a 50% premium over the Bear case valuation of $96.
Cash consumption is high and exceeding management estimates. Based on current cash burn trends and aggressive expenditure, debt issues are forecast for Q2 2017 and Q1 2018, though with its currently underleveraged capital structure, the company should not be burdened by increasing its debt. With margin growth exceeding estimates for both domestic and international streaming, I estimate the international streaming business becoming profitable by 2018 and contribution margin growing to approach convergence with domestic streaming by the end of the forecast period. Cost growth has been high and additions to streaming libraries have approached 100% of revenue as at December 2016. The ability to reduce this ratio gradually in line with membership growth underpins the Base case valuation, and as discussed at initiation cash costs and content amortization (P&L content spend) will be monitored closely as the streaming business becomes established globally.
Q4 2016 results reaffirm the perceived wisdom that membership growth is driven by the popularity of originally produced content. Netflix has been successful in producing popular and critically acclaimed content, evidenced by the success of The Crown in winning Best Drama at the 2016 Golden Globes. Management and analysts are in agreement that high quality original content is a key driver of subscriber growth and retention, and signs are strong on the content front with much-hyped new releases such as The Crown and Gilmore Girls proving popular internationally in Q4, following previous strong viewing numbers for shows such as Luke Cage, and Narcos.
Longer-term, I believe the threats covered in the initiation report remain, but the company is showing encouraging signs of capitalising on its first-mover advantage in the SVOD space to build a strong and resilient enough base to cope. We are yet to see the emergence of meaningful competition but re-emphasise the expected global expansion of Amazon Instant Video (part of the Amazon Prime package) following the release of flagship programme The Grand Tour in over 200 countries in 2016. Domestically, Net Neutrality legislation should be monitored, but there is not currently strong enough evidence to suggest regulations to impede net neutrality will be introduced.
Valuation Risks
The Base case price target of $136 is predicated on 1) Subscriber growth estimates, 2) Ability to reduce content costs, particularly relative to revenue, 3) Increases in revenue per user driven by forecast subscription price increases, 4) Management of cash consumption over the next 18-24 months.
Valuation Inputs
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Ratings methodology
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The author of this article has no financial investment or other conflict of interest related to the subject company or other companies discussed. Any views made or implied in this article represent the author’s opinions. Click here to visit Ross' Contributor page.
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