Monday, April 13, 2009

Netflix: The Short Version

Netflix: The Short Version

Reading about Netflix (NFLX) reminds me of the story of Icarus. Icarus, you will remember, was a high flier who flew too close to the sun. When he did, he crashed to earth. Netflix is ubiquitous for renting out DVD's and Blu-Ray titles by the millions. According to the company's profile, Netflix, 

"provides online movie rental subscription service in the United States to approximately 10 million subscribers. The Company offers a variety of plans and provides subscribers access to over 100,000 digital versatile disc (DVD) and Blu-ray titles plus more than 12,000 streaming content choices. Subscribers select titles at the Company’s Website aided by its recommendation service and merchandising tools. Subscribers receive DVD’s by United States mail and return them to the Company at their convenience using its prepaid mailers. After a DVD has been returned, The Company mails the next available DVD in a subscriber’s queue. It also offers certain titles through its instant-watching feature. Subscribers can watch streaming content without commercial interruption on personal computers, Intel-based Macintosh computers (Macs) and televisions."

"The Company promotes its service to consumers through various marketing programs, including online promotions, television and radio advertising, package inserts, direct mail and other promotions with third parties. These programs encourage consumers to subscribe to its service and may include a free trial period. At the end of the free trial period, subscribers are automatically enrolled as paying subscribers, unless they cancel their subscription. All paying subscribers are billed monthly in advance. The Company stocks approximately 100,000 DVD titles. It has established revenue sharing relationships with studios and distributors. It also purchases titles directly from studios, distributors and other suppliers. In addition, the Company has more than 12,000 content choices licensed for streaming. The Company ships and receives DVDs throughout the United States. The Company maintains a nationwide network of shipping centers that allows it to provide delivery and return service to its subscribers."

"The Company competes with Blockbuster, Movie Gallery, Redbox, Time Warner, Comcast, DIRECTV, Echostar, AT&T, Verizon, Best Buy, Wal-Mart, Amazon.com, Google, Apple and Hulu.com."
Netflix is a fine company that has done a good job growing revenues and earnings. The company's sales have grown 18.9% for the MRQ vs Qtr 1 year ago and 13.2% TTM vs TTM 1 year ago. The five year growth rate for sales is a very strong 38.2%.

Similarly, EPS (MRQ) vs Qtr. 1 year ago is up an astounding 66.7%. EPS (TTM) vs TTM 1 year ago is up 37%. The five year earnings growth rate is an unsustainable 66.4%

The company carries little debt; long term debt to equity (MRQ) is just 10.9%. Total debt to equity (MRQ) is a low 11.3%. The company reports cash and short term investments of $297.3 million and goodwill/intangibles of $100.4 million. Long term debt is just $38 million.

Netflix sports a PE (TTM) of 35X earnings of FY 08 earnings of $1.37. Consensus earnings estimates for FY 09 range from a low of $1.53 to a high of $1.67 with an average of $1.59. Using these estimates, Netflix is selling at 32.3X to 29.6X FY 09 estimates. We estimate earnings for FY 09 to be about $1.75 or 28X earnings.

We prefer to use the P/FCF metric. The company is currently selling at 39.5X trailing free cash flow. We estimate that Netflix will have about $0.81 in free cash flow raising the forward P/FCF multiple to 61X. Projecting out to FY 10, we see free cash flow restrained and rising only to $1.06. This still gives us a P/FCF multiple of 46.6X.

Other standard metrics are also too high. PSR (TTM) is 2.01X; PB (MRQ) is 7.96X and P/Tangible Book (MRQ) is 11.13X. Netflix has seen its price run up by 104% over the past 26 weeks; it is up 57% year-to-date.

By any commonly used metric, Netflix is selling at a price the fundamentals cannot sustain. Though the company has strong growth, this will slow considerably going forward. The company has raised prices yet it has strong competition from Blockbuster, the cable companies and from on-line content delivery systems from major players such as Apple and Google.

We would expect Netflix to be selling in the $8-$12 range or about 10X-14X free cash flow. 

Disclosure: The author has no financial interest in Netflix.




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