It was only a matter of time before the Netflix, Inc. (NASDAQ:NFLX) bears showed up to the party.
Netflix stock has taken off like a rocket ship over the past year, leaving its FANG peers in the dust. Its up 130% over the past 12 months, while the second-best performing stock in the FANG group (Amazon.com, Inc. (NASDAQ:AMZN)) is up “just” 86%.
So far in 2018, the difference is more profound. At its high, Netflix stock was up 70%, and its only March. Amazon, meanwhile, is up “just” 35%.
Up until now, its to clear to see that bulls have dominated the NFLX narrative. But with a double-digit trailing sales multiple, a triple-digit forward earnings multiple, and a 70% gain in just 3 months, Netflix stock was bound to have its fair share of doubters.
Those doubters are finally voicing their concerns. Stifel downgraded Netflix stock from “Buy” to “Hold” while saying that the stock has “sprinted ahead of fundamentals in the short-term”. The Financial Times’ Dan McCrum recently called the rally in Netflix stock “nuts”, while pointing to the company’s massive amount of debt. Widely followed short seller Citron Research highlighted McCrum’s article in saying that NFLX stock is doomed to fall below $300 soon.
All together, the vocal bears are bringing NFLX stock down. On Monday, Netflix was the weakest FANG stock by a long shot.
So are the bears right? In the near-term, yes. Netflix stock has gotten ahead of itself here. But in the long-term, no. Netflix stock will more than double over the next 5-10 years.
Short-Term Pain, Long-Term Gain
Realistically speaking, stocks don’t go up in straight lines. Pullbacks happen. They don’t signal an end to a rally, but they do happen.
If you look at Netflix stock, it’s easy to see why this thing is due for a pullback. It’s up 70% in 2018, and it’s only March.
NFLX has sprinted past its FANG peers to levels no one dreamed of back in 2016. Back then, we were all still debating whether or not huge investment into original content would pay off.
The stock is about as far above its 200-day moving average as it’s ever been. The Relative Strength Index has plunged into overbought territory.
All in all, Netflix stock needs to cool down.
But a cool down doesn’t mean a melt down. Near-term, Netflix stock needs to reset and consolidate. Long-term, though, Netflix stock will roar higher.
Netflix is marching towards global domination. And that won’t stop anytime soon for two reasons.
Netflix Is Not Going Anywhere
The first reason is value.
Netflix gives consumers a lot of bang for their buck. For just $11 per month, Netflix subscribers get access to a seemingly endless library which is consistently being injected with new content. Compare that to cable, which gives you a similarly large and growing content library, but for a much pricier $100 per month. Or compare it to movie theaters, which charge a national average of nearly $10 for one movie.
As long as Netflix keeps injecting its platform with quality original content, the value prop of Netflix will only grow in comparison to cable and movie theaters. Consequently, Netflix adoption rates should continue to soar globally.
The second reason is convenience.
Cable viewing is largely constricted to a cable box. Going to the movies is constricted to the location of the movie theater. But Netflix is on-the-go and offers viewing from anywhere or anything. Plus, Netflix is on-demand (I can watch whatever I want, whenever I want). This enhanced convenience will allow Netflix to grow its adoption rates globally.
Overall, there are 120 million TV households in the U.S. Netflix is already tapping into 55 million of those households, and it’s growing its subscriber base by an unprecedented 5 million households per year. Given the enhanced value and convenience props of Netflix, it is pretty likely that Netflix grows its domestic sub base to 100 million households in 10 years. Netflix should also be able to grow its average price per month from $11 to $15 in that time frame, given the company’s increasing value and low cost relative to cable and movie theaters.
The Long-Term Numbers for Netflix Stock
At $15 per month, a 100 million domestic subs implies domestic streaming revenues of $18 billion.
On the international side, there are 1.6 billion and growing TV households. Netflix was tapping into about 3% of those households (45 million) last year, and is currently tapping into about 4% of those households today (60 million). This 100 basis point jump in international household penetration should persist into the foreseeable future. If total international TV households hits 1.8 billion in 10 years, then Netflix should have an international sub base of somewhere between 180 million (10%) and 270 million (15%).
My best guess in 10 years is 250 million international subs. At $15 per month, that translates into $45 billion in international streaming revenues.
All together, Netflix can realistically hit $63 billion in total revenues in 10 years. Operating margins are at 7% currently, and are growing around 300 basis points per year. This robust margin expansion should persist alongside huge user growth and price hikes. Consequently, it’s easy to see Netflix hitting 30% operating margins in 10 years.
That would imply operating profits of $19 billion in 10 years. Taking out $500 million for interest expense, 21% for taxes, and dividing by presumably 500 million diluted shares, that leads to roughly $30 in earnings per share in 10 years.
Throwing just a market-average earnings multiple of 25 of those $30 earnings implies a 10-year price target on NFLX stock of $750. Discount that back by 10% per year, and you get to a present value of roughly $290.
Bottom Line on NFLX Stock
The bears have arrived. And they are providing enough fuel to send Netflix down in the short term. I think a sub-$300 price tag makes sense for NFLX stock in the near term.
But after some near-term pain, Netflix stock will resume its march higher. This stock can easily double over the next 5-10 years thanks to secular adoption tailwinds in over-the-top television and huge investments into original content.
As of this writing, Luke Lango was long NFLX and AMZN.