Netflix: Flying Too Close to the Sun?
Netflix’s stock has been one of the best performing equities over the past year. Even in a strong stock market, NFLX has done exceptionally well, growing in share value by over 150% in twelve months. Last week, the stock traded in the $400-range, a level previously thought unimaginably high. How has Netflix been able to continually perform so well? How high can the stock soar? And is the stock dangerously overvalued? Recently, investors have found themselves asking these questions and more.
Undoubtedly, most of the growth of NFLX can be attributed to Netflix’s sales growth. Currently, over 125 million people stream Netflix. Since mid-2017, Netflix has gained over 20 million subscribers, contributing to Netflix’s 70% revenue growth and 350% net income growth. This growth in subscribers is partly due to high-quality original content produced by Netflix, with the streaming company making hit shows such as Orange is the New Black and Master of None. This new content is driving more people to Netflix as opposed to other streaming services like Hulu and Amazon Prime. In addition, Netflix has tried to become more accessible by allowing Dish users to access streaming for free. These efforts have paid off for Netflix, and its stock price has reflected these growing revenues and earnings. [1]
In addition, Netflix has utilized machine learning to improve streaming quality. These statistical models overcome some of the challenges present with a service available on a multitude of devices and markets with varying levels of congestion. Machine learning has allowed Netflix to adapt video playback quality based on these factors to minimize buffering. Further, predictive technology has been used to cache programs the viewer is most likely to watch next, thus increasing the amount of time the average viewer spends streaming. The algorithm can also detect and minimize anomalies that might interfere with audio and video quality. These efforts have further cemented Netflix’s status as the top streaming service and allowed it to outperform its competitors. [2]
Despite the effects a looming trade war has had on the domestic equities market, NFLX performed well last week, soaring to nearly $420 per share. However, on Monday of this week, NFLX has its biggest one-day price drop since July 2016, falling 6.5%. There are a few factors contributing to this. First, a trade war may have started to look more likely after the EU put retaliatory tariffs on the United States this weekend. Second, Netflix faced a threat in the European market, namely the creation of a subscription-streaming platform combining ProSieben’s Maxdome VOD and Discovery’s Eursport Player. Finally, Netflix had to fire its chief communications officer Jonathan Friedland over racially insensitive comments he made during meetings. Despite these factors, NFLX rose back up to $400 per share on Tuesday and is expected to continue rising. [3]
How high can Netflix’s stock rise? No one knows for sure, but analysts have attempted to predict. GHB put a price target $500 per share, while Monness Crespi Hardt put a target of $460 and Piper Jaffray a more modest $420. It seems that analysts think the stock can continue to rise, at least for a while, but the possibility exists that the stock is overvalued. It’s difficult to determine a comparative evaluation since Netflix is the only publicly traded streaming service. Amazon, which provides Amazon Prime, has a PE ratio of 209.2x and an EV/EBITDA multiple of 49.44x, both lower that NFLX’s 257.69x PE and 165.40x EV/EBITDA, respectively. However, Amazon provides a variety of other services and products besides Prime, so the comparison is weak. FOX, DIS, CMCSA, and T, the four owners of Hulu, each trade at much lower PE and EV/EBITDA multiples (in the 5x-20x range for each), but Hulu is only responsible for a small amount of the income from each of these companies. It’s difficult to say if NFLX is overvalued or not compared to similar companies, but its ratios are very high. Also troubling is Netflix’s -$1.68 billion operating cash flow, making it the only one of the aforementioned companies to be hemorrhaging cash. However, if Netflix continues to grow subscribers and income at the rate it has been, it may still be worth the investment. [4]
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Written by Jack Vasquez & Edited by Alexander Fleiss
[1] LaMonica, P. R. (2018, June 19). Chill? Netflix stock up even as market plunges. Retrieved from http://money.cnn.com/2018/06/19/investing/netflix-stock-up/index.html
[2] Ekanadham, C. (2018, March 22). Using Machine Learning to Improve Streaming Quality at Netflix. Retrieved from https://medium.com/netflix-techblog/using-machine-learning-to-improve-streaming-quality-at-netflix-9651263ef09f
[3] Spangler, T. (2018, June 25). Netflix Stock Tumbles Amid Competition, Chinese Trade-War Concerns. Retrieved from https://variety.com/2018/digital/news/netflix-stock-stumble-communications-chief-fired-1202856440/
[4] All financial data from Yahoo Finance (retrieved on June 25, 2018) and the Securities and Exchange Commission