Netflix’s subscribers have leaped over the 70 million mark and its share price continues to play a game of cat and mouse around the $100 mark, creating a market capitalisation of $40.28bn. Some analysts are arguing that NFLX is overpriced, and with a price to earnings ratio of 336.04 there is good reason to believe so.
The company has three main competitors: Hulu Plus, Amazon Prime Streaming and HBO (owned by Time Warner Inc.). Their individual revenues and market capitalisations are shown in Table 1.
As we can see from Table 1 there is a variation in the revenues generated and the market capitalisations of each of these businesses. Whilst NFLX focuses on streaming and DVD rental, AMZN has a full range of online retail product lines and TWX includes HBO and other entertainment divisions, such as broadcasting and video games. Although this suggests that their revenues are incomparable, I have filtered the accounts so that the number shown are indicative of HBO revenues in TWX and media content revenues in AMZN media content only. Hulu generates approximately 1.5-1.7bn revenues a year, and it is estimated these revenues are earned more effectively than NFLX due to the inclusion of advertisements in their services. Hulu would be a strong comparable company to NFLX, however due to its complicated ownership and private company status it is difficult to gain information on the company and therefore will not be included in this analysis.
We can see from Table 1 that NFLX is generating revenues above its competitors, except for AMZN. However it is argued in this case that the AMZN revenue figure is inflated, as it includes all media content, not just streaming.
Table 2 shows some key metrics to consider as we undertake a comparable company analysis. The EBITDA multiple is most relevant to our immediate analysis and this falls in the range of 9.66x – 30.45x. To calculate the mean implied equity value per share we first find the mean of this multiple range, times by the EBITDA for NFLX in December 2015 (10K statement), subtract net debt and then divide by outstanding shares.
Using the EBITDA’s for TWX and AMZN we also calculate an implied range from $81.57– $269.04.
This implied equity value per share of $175.34 is much higher than the current trading value at $94.09, but it is not necessarily representative of NFLX’s true intrinsic value. By using EV/EBITDA comparable company analysis we have to be careful; it is important to take into account that AMZN and TWX have more than just streaming content and DVD rental services. AMZN is a large online retailer selling content, services and goods. It is not solely focused on the streaming business. TWX is similar, being a conglomerate of entertainment. Therefore we can see in Table 2 that the metrics are not as similar as we would have hoped, with AMZN in particular having a much larger enterprise value and TWX producing a much higher ROE. These companies are however our best comparison to NFLX in this business space.
Whilst the EV/EBITDA analysis suggests NFLX’s is current share price is quite fairly valued within its $81.57 – $269.04 comparable company range I argue that NFLX is more difficult to fundamentally value than the above analysis suggests. NFLX is operating in a rapidly growing entertainment space and there are varying views from analysts and investors. The FT.com reports that poor financials in the present moment are a result of management foregoing short-term earnings, in a bid to build market share and invest in longer-term profits. However with a return of equity (ROE) of 6.01%, lower than the CAPM estimated value for this stock at:
0.0192+1.44(0.1-0.0192) = 13.55%
Note on numbers: Riskfree = 10 yr Treasury note. Beta = 1.44 Yahoo!Finance. Market return = 10%
NFLX is arguably inefficient at generating shareholder value at the present moment. Motley Fool also argues that to achieve its current market value NFLX would need to have a total of 250 million subscribers. At a growth rate of 6 mn subscribers a year it would take NFLX 29 years to reach this target. Considering most investors’ time-horizon is between 8-12months I would hazard a guess and suggest some behavioural finance is at play here.
There is no doubting that NFLX is a key player in the streaming market and a disrupter of modern media entertainment. It’s focus on original content is creating a competitive advantage in the industry, with big productions such as House of Cards, Orange Is The New Black and Narcos. But whether NFLX’s share price is fairly valued seems to be more of a guessing game in a stock market bubbled by the silicon valley boom, and with few direct competitors to compare to. The industry is by no means safe from outsiders and NFLX faces strong competition from Apple, Google, Hulu, Amazon, HBO, Disney, CBS and just about any other media company innovating forward into the 21st century. NFLX’s book value at ~$5.00 per share is a notable divergence from its $94 share price and investment in new content is creating a debt pile, which is understated in the financial accounts by almost $10bn that is kept in off-balance sheet liabilities. This therefore questions the credibility of its accounts in reflecting the true nature of the firm.
The EV/EBITDA analysis helps us to understand how analysts are reaching their high valuations for NFLX, however that does not necessarily mean they are correct and I would be cautious in going long in this volatile position.
(ProdigyMarkets does not own or have any conflicts of interest in NFLX shares).