Netflix: How Much Is A User Worth?

| About: Netflix, Inc. (NFLX)

Summary

Netflix basically met expectations for revenue and earnings.

Netflix beat subscriber growth expectations by a large margin.

Does the huge increase in stock price after earnings match up with subscriber growth?

Netflix (NFLX) is a great company that is revolutionizing how we watch TV and consume content. After the closing bell on July 17th NFLX announced quarterly earnings results. Revenues beat expectations by roughly $30 million (1% beat) and missed net income by a penny (6.7% miss). Both were roughly inline with analyst expectations. But NFLX announced a huge beat on subscriber growth. They announced net additions of 5.2M vs expectations of 3.2M. This equates to a roughly 60% beat…..but does that warrant the 14% rise in the stock as I write this?

If one subscribes to the efficient market theory one would assume that the stock was priced accurately when the closing bell range on 7.17 with all available information factored into the stock. It had 445.5 million shares outstanding and a price of ~$161 giving it a market capitalization of ~$72 billion. As of right now they have roughly 446.3 million shares outstanding (slight dilution) and a price of ~$183. This gives NFLX a market cap of ~$81.6 billion. So the value of the company rose by almost $10 billion through better than expected subscriber growth. Let’s go ahead and value the additional subscribers. If they added 2 million additional subscribers and the stock went up by $10 billion that equates to roughly $5,000 per subscriber. This seems like a huge increase for a service that charges roughly $10-$12 per month (~$150 per year). This equates to a 30-plus year payback on added subscriptions. This seems like an exceptionally long payback period to me. The only alternative is they raise their prices which I don’t believe is feasible because there are so many alternatives in the streaming and TV space right now. HBO GO costs ~$15 per month. Hulu costs $8 to $12 per month. Sling TV costs $20 to $60 per month depending upon how many channels one wants. Amazon’s streaming service is free with your Amazon prime membership (roughly $12 per month). So given all of these alternatives it seems silly to think NFLX can materially raise their prices and hence the stock market is valuing each additional user at a roughly 30 year payback period.

NFLX

Domestic

International

Total

Adds

1.07

4.14

5.21

Expected

0.63

2.63

3.26

Difference

0.44

1.51

1.95

* Numbers in Millions

** Chart built by author from earnings report

Netflix also increased Q3 expectations on revenue by 3%, earnings by 40% and subscriber adds by 10%, but I still don’t see how this takes NFLX from a $70B company to a $80B company in one day and based upon one additional earnings report. I don’t see how these numbers are contributing greatly to the valuation of the firm. Revenues are barely budging, earnings are going from ~15 cents per share to ~30 cents per share (~150 P/E) and even if these additions of 400,000 are added to the 2 million they added during the quarter it still values each subscriber at roughly $4,000. This is still a 26 year-plus payback period and still seems like an absurdly high multiple for the market to value subscribers. They also stated they will need to continue to run negative free cash flow for the foreseeable future and add at least $2 billion in debt in the near future.

NFLX - Q3

Original

Revision

Increase

Revenue

2.88

2.96

2.92%

Earnings

101.60

143.00

40.75%

Adds

3.99

4.40

10.28%

* Chart built by author from earnings report

I wish everybody luck in their stock picking, but this is an instance where the valuation has certainly gotten ahead of the stock in my estimation and it continues to jump up on subscriber growth which is certainly growing. But given how much Netflix charges users, its massive investments in content, extremely long payback period for new subscribers and grossly negative free cash flow, the stock is valued greatly above the earnings potential.

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.

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