Broken Growth Stocks: Netflix

May 13, 2022 5:29 AM ETNetflix, Inc. (NFLX)14 Comments

Summary

  • Reed Hastings was early in his insider purchases of Netflix earlier this year and investors can now buy the stock for less than half what he paid in January.
  • While subscriber growth declined in Q1 2022 and is expected to decline again in Q2 2022, there are other levers the company can pull to increase revenue.
  • The stock is cheap whether you use comparative valuation metrics or a DCF model. Earnings estimates have already come down significantly over the last 90 days.
  • I do much more than just articles at Inside Arbitrage: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

Netflix App on a Apple Tv

mphillips007/iStock Unreleased via Getty Images

A friend of mine recently asked me what I was seeing in terms of insider buying by management teams at beaten down technology and growth companies. With many of these companies back to pre-pandemic levels and in some cases even lower despite growth in their core businesses, we would normally expect to see an uptick in insider buying at these companies.

A quick check of companies like Zillow (Z), Affirm (AFRM), Upstart Holdings (UPST), Doximity (DOCS), Coursera (COUR), Etsy (ETSY), Fiverr (FVRR), Palantir Technologies (PLTR), Shopify (SHOP), Meta Platforms (FB) and Amazon (AMZN) showed no insider buying at any of these companies and in most cases, there have been no management insider purchases for years or since the company went public. We did see insider buying at Carvana (CVNA) but that was related to their secondary offering and the amount of buying paled in comparison to the selling that preceded it as discussed in our Insider Weekends article here.

The only companies where we have seen insider buying recently are Uber (UBER) with Dara Khosrowshahi picking up 200,000 shares for $5.35 million last week, the CEO of DocuSign (DOCU) purchasing $5 million worth of shares, Anthony Noto of SoFi Technologies (SOFI) and his Head of Operation picking up shares multiple times, the CEO of WeWork (WE) purchasing 30,000 shares and a cluster of insider purchases at PayPal (PYPL). The DOCU, SOFI and We purchases all occurred in March. Only 6 out of the 45 "broken growth" stocks I am tracking saw insider purchases despite this big sell off.

Insider Purchase at Netflix

Reed Hastings of Netflix (NASDAQ:NFLX) did buy shares but his purchases were in late January at prices that are more than double what they are right now. This was his first insider purchase of Netflix in the twelve years we have been tracking insider data. Insiders often buy to signal the market and also tend to be early with their purchases. They suffer from the same anchoring biases that many of us investors do and when they see a steep drop in the price, they tend to buy shares even if the drop is justified.

Netflix currently trades at a 55% discount to the price Mr. Hastings paid in January when he bought 51,440 shares at an average price of $388.83. The stock had already declined by nearly 45% from its peak of over $700 when he purchased shares. A $20 million purchase by Mr. Hastings is a literal drop in the bucket considering his net worth and he has not purchased again despite the continued drop in the stock. With earnings season almost behind us and earnings related quiet periods ending, I will not be surprised if we start seeing more buying in some of these broken growth stocks.

Subscriber and Revenue Growth

Getting back to Netflix, the stock was hammered last month when the company reported its first drop in subscribers in Q1 2022 and guided towards a 2 million decline in subscribers in Q2 2022. The stock is down more than 50% over the last three years, underperforming the S&P 500 by a whopping 94% during that period.

Netflix Three Year Chart

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During those three years, revenue increased from $17.63 billion to $30.4 billion (TTM) and subscribers increased from 151.56 million in Q2 2019 to 219.64 million (estimated) for Q2 2022. The stock was clearly trading at an inflated valuation late last year just like the rest of the market and it was a time for caution as I outlined in this article last November. Reversion to the mean often overshoots the mean on the downside and this is what I believe has happened with Netflix.

With certain markets like the U.S. and Canada maturing for the company, it will pull other levers to grow revenue including increasing subscription fees, cracking down on password sharing where over 100 million subscribers are sharing their password, entering adjacent markets like gaming and potentially launching an ad-supported tier. Considering both HBO Max and Hulu offer lower priced ad-supported subscription options, it makes sense that Netflix might pilot an ad-supported version, especially in countries where average revenue per user is low. In fact, I pay almost as much each month to YouTube as I do to Netflix to avoid in the incessant ads that show up on YouTube videos.

Streaming Competition

Consumers do have other streaming options available to them these days but many of these services, with the exception of HBO Max, do not have the depth of content that Netflix does. Disney (DIS) managed to amass an impressive 137.7 million subscribers for its Disney+ service by pricing its service low and providing very large discounts in the early days. On the content side, Netflix does have strong competition from HBO Max and Hulu but there is no reason these services cannot co-exist and consumers often have more than one streaming service at the same time. Instead of having hundreds of cable TV channels and complaining that there is nothing to watch, we will instead have a few streaming services and complain that there is nothing to watch. Feeding this constant craving for new content is both difficult and costly but Netflix has a deep library of its own and licensed content to satiate this demand. The company could also go to a different model of releasing an episode a week for new seasons of some of its popular series like Stranger Things, Ozark and The Umbrella Academy. This might discourage surfers that sign up for a short period, binge watch certain series and cancel their subscriptions.

Netflix Ozark Series

Netflix

Valuation

Netflix reported earnings of $3.53 per share in Q1 2022. After 15 downward revisions during the last 90 days, consensus analyst estimates are for Netflix to earn $10.97 for the full year 2022 and $12.62 in 2023. The company is trading at a forward P/E of 15 and a forward EV/EBITDA below 13.

Plugging the consensus analyst estimates into the first two years of a DCF model and assuming an EPS growth rate of 10% in year 3, declining 3% a year through 2031, an 8% discount rate and a 2% terminal growth rate, I get an intrinsic value of $232.16 per share. This provides 33% upside to what I think are conservative estimates. The stock currently trades well below that intrinsic value. A financial model or a DCF model is only as good as its assumptions and it's entirely possible that the future may unfold in a different manner.

Conclusion

Growth-at-a-reasonable (GARP) has been a strategy that has worked well for me and it is not often that you get to own a quality name at a very attractive price. Netflix, like most companies, has stumbled in the past (remember that Qwikster fiasco?) and each time it has stumbled, it has provided a great buying opportunity. While increasing competition and maturity in developed markets are significant headwinds for the company, with the founder at the helm and a leading position in streaming, the company still has a lot of unrealized potential. The road is likely to be bumpy both because of company specific issues and general market conditions but if investors are willing to be patient and build a position over a period of time, they could benefit from the current opportunity provided by Netflix.

Insiders Sell For Various Reasons But Only Buy For One Reason, They Expect The Stock To Go Up.

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This article was written by

Asif Suria profile picture
9.61K Followers
Comprehensive tools and detailed analysis for event-driven investors

I am an entrepreneur and investor with a focus on event driven strategies including merger arbitrage, spinoffs, (legal) insider trading, buybacks and SPACs. I was one of the earliest contributors on Seeking Alpha and started publishing here in 2005. For more than a decade I have been writing every week about M&A and interesting insider transactions. My work has been mentioned in Barron's, Dow Jones, BNN Bloomberg and other publications.  

I have been an active investor for more than two decades and my background in technology has helped me built tools that inform my investing process, especially as it relates to event-driven strategies that require updated data and processes. The focus on my Inside Arbitrage service is to provide investors with the right combination of tools and analysis to help them take advantage of strategies that can perform well across market cycles.  

Disclosure: I/we have a beneficial long position in the shares of NFLX, DOCS, COUR, Z either through stock ownership, options, or other derivatives. 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.

Additional disclosure: I hold a short position in WeWork (WE) through put options. Disclaimer: Please do your own due diligence before buying or selling any securities mentioned in this article. We do not warrant the completeness or accuracy of the content or data provided in this article.

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