Since the last time I wrote about NetflixInc. (NASDAQ:NFLX), in June 2022, the stock is up more than 150%. Aside from the general market recovery, the latest excitement for Netflix comes from the company gaining traction in its market. efforts to increase profitability after a growth hiatus in early 2022. Netflix’s crackdown on password sharing initially encountered some difficulties. skepticismbut 24 million additional subscribers over the past year have clearly helped the market shrug off concerns that the crackdown would only be a one-off improvement. The increase in operating margins has undoubtedly also been beneficial, as consumers have mostly benefited price increases in the process.
However, repression is not a factor that can continue to stimulate growth indefinitely. Management expects this to provide an advantage in the coming quarters. It’s unclear whether this is fully priced in or not, given Netflix’s now higher valuation metrics. The writers and actors’ strikes also provided a increase cash flow content spending temporarily reduced and competition in the industry increased.
I initially started writing this article with a sustaining note in mind. But Netflix is the market leader and an innovative, beloved company with room for growth and further price increases in the long term as the industry consolidates. Although I don’t currently own it, I think there’s a good chance it will return to $700/share levels over the next 2-3 years.
Notable rebound in free cash flow (helped by strikes)
The long thesis behind Netflix has always been that it is the leader in streaming, with pricing power and the ability to increase margins over the long term as the subscriber base continues to grow. This story has largely continued to play out, with the company’s operating margin recently hovering around 20%, despite the setback of stalled growth in 2022. Netflix’s stock price has recovered accordingly , regaining much of what it lost after November 2021, when it increased. above $700/share.
Netflix originally expected approximately $3.5 billion of free cash flow (FCF) in 2023, although it has since revised that figure upward to $6.5 billion for fiscal 2023 as strikes have reduced content spending and paid sharing has achieved success. Nonetheless, for argument’s sake, if Netflix’s normalized level of FCF (minus strikes) is around $5 billion, then Netflix is still trading at a high multiple of around 42x of FCF.
The undisputed leader in streaming but will not be insensitive to the competition
Netflix is the undisputed leader in streaming and will likely remain so in the future. But I’m not as sure that they will remain as impervious to competition as many think. Competing services have made big strides recently, each adding tens of millions of subscribers in recent years. At the very least, the now more crowded market should eventually help erode the growth available to all market players, including Netflix.
There’s been a lot of talk about competing streaming services bleeding money. But in most cases, they have passed peak losses – Disney expects break-even point in 2024. In Warner Bros. Discovery (WBD), she declared that she had achieved balance in 2023S1. She was concerned about her merger in 2022 and was not at the point of prioritize growth. Amazon Prime Video doesn’t seem to be the best content producer for me, but it has the obvious advantage of being associated with Amazon Prime.
However, Netflix’s first-mover advantage will likely last for a long time – they just need to keep doing what they’re doing. The formation of consumption habits means a certain degree of tolerance towards the prices offered by Netflix, regardless of what competitors offer. And there’s also a virtuous cycle resulting from people wanting to watch the same things they hear other people talking about. This benefits Netflix the most due to the simple fact that they are the largest streaming service, i.e. with the most scale and distribution, even though they are relatively more saturated in some markets keys.
The rise in crackdowns on password sharing is not indefinite but is expected to last for a few quarters
Netflix had estimated that more 100 million non-paying households people around the world were using its service with borrowed passwords. Since the repression spread to the United States in May 2023, Netflix added about 15 million subscribers over the past two quarters. Although we don’t know how many of them are the result of repression, it’s probably a good portion of them (although management stated that the paid share additions were “on top of organic elements that were also very healthy, i.e. they were not driven by paid share growth”). Their growth remained almost stable at the start of 2022, falling into negative territory in 2022. 2022Q2following the progression of the pandemic.
Even if Netflix only manages to capture half of these non-paying households, then it is logical to believe that a similar level of subscriber additions could occur in the coming quarters, bringing Netflix to almost 300 million subscribers. subscribers. Just like with price increases, some households will initially resist paid sharing, only to sign up or upgrade over time as they accept that streaming is one of the options for sharing. most affordable entertainment available. Presumably, competitors could also acquire some of these homes, although peer subscriber additions have been uneven in 2023. 2023Q2 and third-quarter 2023 calls, Netflix management said it expects earnings to occur in the coming quarters.
An ambitious valuation but for a company that continues to keep its promises
Netflix has returned to a level where its valuation metrics make the bull case less obvious, but it’s still about 30% off its high at a time when the market is nearing record highs.
Granted, a lot is different from when NFLX was near $700/share in late 2021:
- There will be less low-hanging fruit as paid sharing and the ad-supported tier continue to gain traction.
- Competitors now have more consistent offerings and will continue to expand into new geographic areas.
- Consumers now face higher interest rates and a higher cost of living in general.
- The total addressable market is probably not as large as once thought. While 300 million subscribers seem within reach, the path to reaching 500 million and beyond is less clear.
- The fall in Netflix stock price in 2022 is still recent.
And yet, initiatives to increase profitability are still in their infancy. If industry consolidation continues, there could also be less pressure so that content spending keeps pace with revenue and subscriber growth. For investors with a long-term horizon (e.g., 2-5 years), the industry is likely to emerge from its somewhat dark days of streaming armageddon, with Netflix at its helm.
(In terms of price increases, we’ll only see the limits when subscriber churn starts to offset more of the profits generated by higher average revenue per user. I don’t think we’ve seen any indication clear of what is happening, again.)
I would expect Netflix to eventually return to its previous high of around $700/share, given that it is a high-quality market leader that will benefit from further price increases and a improved operating leverage over the long term. However, compared to the over 180% gain from the 2022 stock price low, this will likely occur at a much less impressive annualized growth rate than the last 18 months. It will also depend on the sustainability of the paid sharing impulse.
As always, it will be interesting to see how this plays out. I was tempted to end this stock, with a hold rating, after the significant rebound that followed my previous NFLX article. This may not be the best opportunity to beat the market. But re-examining the situation, I expect there to still be decent stock price appreciation over the long term, relative to the current level. I look forward to hearing your thoughts on NFLX.