Netflix’s share price has tanked 40% since the start of the year, and that’s just a span of 3 weeks. The key reasons were a mix of the macro environment (interest rate rising causing a valuation reset) and Netflix’s earnings guidance for the next quarter.
Their latest earnings per share of $1.33 crushed consensus estimates of just $0.82, while revenue of $7.71b was in line with expectation.
Netflix added 8.3m customers in the past quarter but the projection for Jan-Mar 2022 was a low 2.5m. That is even less than the 5.9m forecast by analysts. Netflix share price tanked 20% on that faithful day the guidance was given.
It should be obvious by now that the positive effect of the pandemic – putting people at home where they have nothing to do, so they subscribe and watch Netflix – is wearing off.
Majority of the countries have decided to live with Covid even though Omicron is a more contagious variant.
As such, people are getting out rather than staying home with Netflix. Hastings, CEO of Netflix has also cited that the growth in Latin America is slowing as the economy is struggling to recover from the pandemic and it has affected the demand for the streaming service.
With such a big drop in the share price for a famous company, some investors will naturally be wondering if its current price is an opportunity to buy it at an attractive price, if the current growth is a temporary setback.
Let me share my view on this.
Netflix’s slowing growth rate
Firstly, Netflix’s revenue growth rate has been slowing every year since 2018:
- 2017: +32.4%
- 2018: +35.1%
- 2019: +27.6%
- 2020: +24.0%
- 2021: +18.8%
It is normal that new customers are increasingly difficult to get once you have a large customer base. Every company will become a victim of its own success at some point – the easier customers have been captured and now more persuasion is needed to attract yet-to-be customers (they would have been customers already if they didn’t need more convincing.)
Netflix’s true economics
For my personal case, I watch Netflix but I don’t pay for it. I leech my wife’s subscription.
How is Netflix going to persuade me to pay for a separate subscription?
The unit economics for Netflix is by the household and not the individual. I would even argue that there may be friends and relatives sharing an account.
Their TAM is huge, but…
One way is to increase their subscription fee which Netflix has done in a handful of occasions.
My super rough estimate is that there are 1.58b households in the world (using an average of 4.9 pax per household. Do keep in mind that using average can be “dangerous” sometimes and this estimate includes poorer countries that may not be able to afford Netflix. But, let’s just assume a blue sky scenario here.
Netflix has 222m subscribers currently (14% of total households). That means Netflix still has another 1.36b households to sell to. It is a huge total addressable market (TAM).
But Netflix is not the only player in town.
Over the years more streaming competitors have come online – Disney+, Amazon Prime Video, Apple TV+, HBO Max, just to name a few. Hence, Netflix’s market share has shrunk but at the moment, they are still able to command almost half of the market.
Does Netflix have the economic moat to further protect its market share?
I would say yes because it benefits from economies of scale. Netflix has commissioned many exclusive content on its platform and many have gone on to win awards, as well as break viewership records. The more subscribers Netflix has, the more capital they can get to produce more great exclusive content, and in turn retain current customers and attract new ones – a virtuous cycle.
Streaming non-original content is no longer viable nor attractive. And you need decent budgets to create blockbuster shows. Not half-hearted efforts as seen in Amazon and Apple. This is a personal view though – Amazon and Apple’s selections suck. The only alternative that is attractive to me is Disney+ because of the exclusive Marvel shows.
So Netflix has some moat flywheel in this – they have the biggest subscriber base to provide the capital and they have the experience to create great exclusive content.
Unless Amazon and Apple are willing to splash capital to fight the streaming war, Netflix will continue to enjoy the advantageous position.
The Gaming Space
That said, the area to watch now isn’t just Netflix’s competition against other streamers.
It is competing for leisure time and another big space would be games. If someone is playing games, he wouldn’t be watching Netflix and its value proposition declines. Hastings held this view and Netflix has been deliberately expanding into games.
Come on, I don’t even play mobile games and why would I go an extra step to play Netflix games?
I think a possible strategy is to create games off their Netflix originals and make sure that there is no other places to play the games except on Netflix. Squid Game comes to mind.
Making ancillary products to reap maximum benefits out of a hit show is a proven model. This is what Disney has done very well – merchandise, amusement parks and royalties. Netflix can squeeze more profits out of the same customers instead of just attracting new ones.
Netflix’s Valuation
Next, we talk about valuation.
Using 5-year average price metrics, Netflix is trading below most of them currently.
- Current PS is 5.6 while its average was 9.2.
- Current PE is 33 while its average was 138.
- PEG ratio is 1.6 vs its average of 2.5.
Netflix stock price doesn’t look expensive but do note the declining growth rate and 5year average may not be a good indication as such (valuation should be higher in the past when the growth was higher).
Netflix is a mature stock now and no longer a fast growing one. It is becoming more like Disney whose current PS, PE and PEG are 3.7, 123 and 0.99 respectively.
What’s a possible entry price for Netflix?
Hence I would think that using PEG ratio less than 1 would make sense for Netflix. If so, a better price would be around $225 or below.16.
That said, Bill Ackman has been a buyer. His hedge fund had announced that they have bought up $1b worth of Netflix shares and is now a top 20 shareholder of Netflix.
Buffett has a good rule of thumb for valuation – it should be obvious to you that it is cheap and you don’t need to do complicated modelling to arrive to the conclusion.
Right now, I am not sure if Netflix price is good.
Want to learn how you can value stocks like Netflix? I’ll be sharing how at my upcoming webinar, you can register here.
The TAM is overestimated. Is Netflix available in China? Also you need to exclude those living in poverty/near poverty, and those without high-speed internet, say 50% of world population. Also exclude those non-english speaking. So TAM is only 500m at most.