Ben Graham's old line about the market being a voting machine in the short run and a weighing machine in the long run feels relevant to Netflix (NFLX) right now.
Twelve months ago -- and to some extent, six months ago -- Netflix was seen as a company that could do no wrong, and was afforded an enterprise value (EV = market cap plus net debt) north of $160 billion. Arguably, this valuation priced in quite a lot of future subscriber growth, while also assuming Netflix would be able to carry out a string of additional price hikes and moderate its spending growth enough for free cash flow (FCF) to surge as its top line swelled.
Back in May 2018, when Netflix's shares first jumped above $350, I noted how small of a margin of error its stock appeared to have. Based on some back-of-the-envelope math done at the time, I estimated Netflix was trading for 17 times its 2022 FCF even if its subscriber base more than doubled by 2022 to 270 million, its average revenue per user (ARPU) rose by about 30% to $13 and its cash content spending, which rose to $13 billion last year slowed to a 15% compound annual rate.
Today, with its shares having tumbled to $265 amid worries about a Q2 subscriber miss that followed price hikes and the impact of Disney's (DIS) Disney+ service and Apple's (AAPL) TV+ service, Netflix's EV is slightly below $125 billion. This still isn't inexpensive, particularly given some of the concerns that recent events raise about how quickly Netflix will be able to raise prices in the future. However, given all of the things that Netflix still has going for it, its selloff does put shares at least within striking distance of being attractive for long-term, growth-oriented investors.
While Disney+, which will cost just $6.99 per month or $69.99 per year when it launches on Nov. 12th in the U.S., does look poised to quickly rack up a lot of subscribers, it's far from a given that Netflix will see large numbers of cancellations after Disney+ launches and some Disney films subsequently leave Netflix. For starters, the fact that (unlike Netflix) Disney+ is focused exclusively on "family-friendly" programming makes it unlikely that any Netflix subscriber who frequently watches PG-13 or R-rated programming will find Disney+'s launch to be enough of a reason to cancel Netflix -- even if he or she signs up for Disney+.
Second, though its international footprint should grow in time, Disney+ is only launching in four non-U.S. markets in November -- Canada, Australia, New Zealand and The Netherlands. More than 60% of Netflix's subscriber base at the end of June was located outside of the U.S., and international markets are now driving the lion's share of its subscriber growth.
Third, while Disney+ does undercut Netflix's pricing, Netflix is still a pretty good value relative to pay-TV. Whereas Netflix's popular Standard (HD) plan costs $13 per month in the U.S., American pay-TV monthly ARPUs are generally above $80. Pay-TV ARPUs are meaningfully lowers in most foreign markets, but are still often above $30 in developed countries.
It's worth adding here that Netflix has long been competing against a well-funded, high-profile rival that has been undercutting it. Namely, Amazon.com (AMZN) , whose Prime Video service is bundled with a subscription to Amazon Prime, which costs just $119 per year in the U.S. and of course features a lot more than just a video streaming service.
Meanwhile, though Apple's aggressive pricing and bundling strategy for TV+ could help drive some incremental hardware sales -- TV+ is currently provided for free for a year with an iPhone, iPad, Mac, iPod or Apple TV purchase, and costs $4.99 per month otherwise -- the service's limited content library prevents it from being a large threat to Netflix or other streaming services for the time being. Though more content will arrive in time, Apple's Sep. 10 press release for TV+ only lists nine originals as being available when TV+ launches on Nov. 1.
And regardless of which streaming service one is comparing Netflix to, its giant and unmatched content budget, which is made possible by its unmatched scale among subscription streaming services, remains a big competitive strength. Aside from giving subscribers a massive total library of original and licensed content to choose from, this scale makes it possible for Netflix to make investments in a variety of niche and foreign-language content pay off in a way that rivals with fewer subscribers are hard-pressed to date.
One also can't ignore how Netflix is able to leverage the massive volumes of viewing data it generates to inform future content investments, or the considerable R&D investments it has made to optimize its viewing experience for many different regions, device types and network connections. And given the quality of their decision-making to date, together with the fact that (unlike many rivals) their attention is focused almost exclusively on their company's streaming business, one has to view Reed Hastings and the rest of Netflix's senior leadership as a competitive strength.
With all this said, there is some risk that the arrival of Disney+ and Apple TV+, together with the ongoing presence of Prime Video, will make Netflix more reluctant in the near-term to carry out additional price hikes. With prices hikes in the U.S. and elsewhere having been carried out fairly recently, Hastings & Co. might feel that it's best to wait until Disney+'s subscriber growth has cooled a bit before mulling another price increase, and that of course would impact near-term ARPU growth. However, this would simply be a moderately negative event, rather than a disastrous one.
Netflix is currently expected on average by analysts polled by FactSet to have 203 million streaming subscribers by the end of 2020, and 252 million by the end of 2022. As a result, if Netflix's EV drops to around $105 billion, it will be equal to a little over $500 per expected 2020 subscriber, and a little over $400 per expected 2022 subscriber.
Should Netflix start approaching such levels, long-term investors who still believe in its story, and are willing to stomach some near-term volatility, might want to take a look.
