$NFLX Fundamental Thoughts – House of Cards or the Future of TV?

by Enis June 17, 2013 2:06 pm • Commentary

Netflix is up 7% today after an announcement of another content deal, this time with Dreamworks (DWA).

NFLX is clearly a hard-to-value stock.  Its volatility over the last few years is a simple testament to that difficulty.  Here is the 4 year weekly chart:

4 year weekly chart of NFLX, Courtesy of Bloomberg
4 year weekly chart of NFLX, Courtesy of Bloomberg

Earnings momentum is a key factor.  The company earned $2.96 in 2010, $4.26 per share in 2011, and almost nothing in 2012.  It is slated to earn $1.45 in 2013, which is significantly less than its 2011 earnings number, despite a stock price in a similar place.  So why are investors paying up for the stock?

I see 2 aspects of the NFLX story that are unique.

1)  Online video is a new frontier.  Internet speeds globally have finally advanced enough that streaming video has quickly become a viable alternative or attractive supplement to traditional TV.  Mary Meeker had her popular internet trends slideshow last month, and this slide was one of the most frequently cited:

Screen Shot 2013-06-17 at 1.39.29 PM



The intended takeaway was that mobile had plenty of room to grow in terms of advertising dollars.  While that’s likely true, one thing I took away from this chart was the continued dominance of TV for the advertising industry.  In that sense, the simple fact that NFLX has 40 million global subscribers is quite valuable for its future potential.  Even though NFLX does not advertise now, I could see them introducing advertising in the future for potentially reduced rates for their subscribers, especially if their original content library grows.  But how do you value that future opportunity?  Very hard to say.

2)  NFLX is highly levered.  Microfundy had a fantastic post explaining this leverage back in April, with this key conclusion:

I believe this is the reason that over the last few years $NFLX has probably been the single highest beta stock in the S&P500. The company is the epitome of leverage. It isn’t your typical financial leverage, and it isn’t even your typical operating leverage. But if subscribers grow as bulls think, and somehow their content costs stay stable or even decline – cash flow will flow straight to the bottom line, and you’ll have a cash cow. If however (which were the worries last year,) competition causes subscriber growth to stall, then the company is toast. Liabilities are just way too high to compensate.

That leverage is a result of its large upfront costs for content, similar to the deal announced this morning with Dreamworks.

In the end, it all comes down to subscriber growth for Netflix.  That’s the main metric investors are watching, not current earnings.  The rapid subscriber growth the company has seen in the past year is the reason why the stock has quadrupled.  Whether it maintains that growth is the crux of the story.