Just before I started my valuation of Netflix (NASDAQ:NFLX), Wall street Journal reported that Comcast (NASDAQ:CMCSA) is in discussion with Apple (NASDAQ:AAPL) about launching a live TV service, which would use Apple's set top box and get Comcast's infrastructure. This report brings the discussion on "managed services" back into the spotlight especially when the severity of these conditions is up for a debate. Even though Netflix shares dropped nearly 8 percent on this news, this discussion in-fact can be positive for streaming companies such as Netflix.
In an earlier article, I argued how Netflix is developing strategic advantage, raising the barriers to entry by focusing on selectivity, capacity and shifting its competencies to grow its subscriber base. Under the surface, this report sheds light on the intensifying fears among cable TV operators which see subscribers losses and concerns the younger generation consumers will forgo paying for the cable TV altogether.
- Netflix ended 2013 with over 44 million subscribers and with expectations of 48 million subscribers at the end of Q1 2014. According to Pacific Crest Securities, "Netflix can reach 134 million global streaming subscribers: 64 million in the U.S. and 70 million in international markets."
- Netflix currently faces strong headwinds as it competes with conglomerates such as Comcast, Verizon (NYSE:VZ) and the content owners for content licensing. To overcome the challenge of content licensing, Netflix launched its own original content, enabling it to grow subscriber base and the revenues. Netflix is competing in an industry, which is capital-intensive and creating an original content library is the only way it control the price.
- Netflix has elegantly capitalized on shifting online landscape - integrating customer convenience and value proposition.
- For the next 5 years, revenue is expected to grow 21.50 percent each year and decelerate towards growth rate of the economy after 5 years.
- International expansion is a key growth driver for Netflix's valuation.
- Netflix will need to expand its pretax operating margins (current levels of 8.54 percent) to create more shareholder value.
- Business reinvestment needs will grow by 16.9 percent yearly to expand the original content offerings.
- Incremental working capital needs will drift higher.
My fair value estimate for Netflix is $128 per share, 66 percent lower than the current market price. In order to realize the subscriber growth by 2020, Netflix will need to reinvest $8.3 billion to generate the expected revenues. Incremental reinvestment requirements highlight a shortfall of $1.5 billion - which needs to be raised either through an equity offering (selling additional 3.9 million shares at today's closing price or by raising debt.
I will be more than happy to share with readers the valuation model I used for estimating the value for Netflix share price.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in NFLX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Will initiate short position via the options