An Acquisition Premium Of About 25% Already Included In The Share Price

| About: Netflix, Inc. (NFLX)
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Summary

Reaching demanding consensus forecast does not justify current share price.

Impressive subscription and revenues growth, but not profitability.

The standalone fair value seems to be in the $50-$80 range.

Forecast assumptions
I have used the free Equity Analysis Model from SimulationFinance.com to estimate Netflix's (NASDAQ: NFLX) fair value. The forecast is based on Netflix's historical financial performance and current consensus forecast. More charts from the analysis is available here. I have copied historical financial data from Netflix's Investor Relation Homepage. The below image shows the historical financial data copied from Netflix's spreadsheet and pasted into the Equity Analysis Model.

I then clicked the Generate forecast button to create an analysis based on extrapolation of the historical development. This will create forecast assumptions based on the historical trends. It also will calculate historical standard deviations and correlations used in the analysis to create fan charts and distribution charts. I will change some of the forecast assumptions further down in this analysis. The below image shows the extrapolation assumptions chosen.
GenerateForecastFromHist.png

After having automatically generated forecast assumptions based on the historical development I then manually change some forecast assumptions to reflect the consensus forecast. The below image shows Netflix consensus forecast from 4-traders.com.

The below image from the Equity Analysis Model shows the forecast assumptions used in the calculation. The forecast assumptions are manually adjusted using the Adjust button to reflect the current consensus forecast.

The below images compare consensus forecasts (left hand side) with the forecast used in my analysis (right hand side).

Consensus forecasted revenues in 2018 is $13.143 billion and my revenues forecast for 2018 is $13.167 billion. Consensus forecasted net income in 2018 is $944 million and my net income forecast in 2018 is $931 million.

Forecast
All the statements and charts below are calculated in the Equity Analysis Model.
The below table summarizes the next six quarters of the forecast.

NFLX ForecastStatements.png

The below chart shows the historical and the assumed future revenues. Historical data with dark blue columns and the forecasted data with light blue columns. I assume revenues increase from about $1.9 billion in Q1 2016 to about $3.8 billion in Q1 2019. This implies a quarterly growth of about 5.6%.

The below chart shows the historical and assumed future EBITDA. I assume EBITDA increases from about $107 million in Q1 2016 to about $525 million in Q1 2019.

The below chart shows the historical and the assumed future earnings per share.

The below image from Marketbeat shows the consensus quarterly forecasted earnings per share. As an example, the highest earnings per share estimate in Q4 2017 is $0.39 and in my forecast earnings per share in Q4 2017 is $0.35. That is, my forecast is rather aggressive.

Valuation
Based on the discounted cash flow valuation method, assuming a weighted cost of capital of 8% and perpetual growth of 4% from the end of 2018. The below image shows the calculated fair value per share based on the assumptions above. That is, the fair value per share is about $54 (the column to the right). Current share price is about $103.

One can argue that the above fair value calculation indicates a too low fair value due to too few explicit forecast periods. That is, one can argue that Netflix is expected to experience superior earnings growth for more than the next three years and thus reach a higher long-term sustainable earnings margin. I will try to include this in the analysis below.

Confidence analysis
The Equity Analysis Model allows to include uncertainty assumptions in the forecast, that is, standard deviations and correlations. In this example, they are automatically calculated based on the historical financial data. Calculated quarterly historical standard deviation in revenues is 1.26%. Calculated quarterly historical standard deviation in costs is 1.07%. The Equity Analysis Model calculates multiple scenarios based on these standard deviations and the results is available in fan charts and distribution charts.
The below chart shows the historical and the assumed future EBITDA margin with uncertainty assumptions.

The black line shows the historical development and the dotted line shows the main case for assumed future development. The darkest blue area shows the range containing 75% of the calculated outcomes. The two darkest blue areas combined shows the range containing 90%, and the total blue area shows the range containing 95% of the calculated outcomes.
The below chart shows the assumed possible development in earnings per share.

The below chart shows the calculated fair value per share range. That is, fair value per share range is between $40 and $76 per share. Based on the same valuation assumptions as above.

The horizontal axis shows the distribution of calculated fair value per share, and the vertical axis shows the probability of each outcome. The percentages on top of the bars have been chosen to show the accumulated probability, starting from the left. That is, it is calculated to be about 90% probability that the fair value per share is below $61.88.

What is possible EBITDA margin for Netflix?
In the below table I have summarized the 2015 EBITDA margin for some media companies. Comcast (NASDAQ: CMCSA), Disney (NASDAQ: DIS), Time Warner Inc. (NASDAQ: TWX) and CBS Corporation (NASDAQ: CBS). Source: 4-traders.com.

NFLX Ebitda comparison.png

The consensus forecast above indicated that by 2018 Netflix's EBITDA margin would be between 14% and 15%. In my analysis on the Equity Analysis Model I click the Adjust button to change my forecast to include that the EBITDA margin gradually increases to 22% in the first quarter of 2019. That is, I assume Netflix reaches an EBITDA margin that CBS Corporation has today. I also increased the quarterly standard deviation in revenues and costs by 1 percentage point each to respectively 2.26% and 2.07%.
I do not know about any technological edge, or content edge that justifies assuming that Netflix should experience a higher EBITDA margins than their peers.
The below image shows the EBITDA assumption change made.

The below chart shows the new assumed possible development in earnings per share.

The below image shows the new calculated fair value per share. That is, the fair value per share is now calculated to be about $88 (the column to the right).

The below chart shows the new calculated fair value per share range. That is, fair value per share range is between $61 and $116 per share.

Summary
Netflix is a great company in an attractive market. However, I do not believe that Netflix's own earnings prospect justifies current share price. There seems to be an acquisition premium included in the current share price. The standalone fair value seems to be in the $50-$80 range. Is the current implied premium justified?

Supporting Documents

  1. NFLX_May_25Company.pdf

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.