I know, I’m harsh on Netflix, Inc. (NASDAQ:NFLX) stock. I love the service and the content is terrific. I just don’t get the $116 billion valuation on $558 million of net income. But I’m getting ahead of myself. Let’s look at the fourth-quarter numbers for NFLX stock, because they were really quite good in many ways.
Average paid streaming memberships rose 25%, pushing global streaming revenue up 34%. Operating income rose to $245 million from $154 million, with margins of 7.2%. Earnings per share (EPS) came in at 41 cents vs. 15 cents the year before. For the year, revenues rose from $8.8 billion to $11.7 billion, operating income rose from $380 million to $839 million, and net income rose from $187 million to $559 million.
Those are terrific numbers.
Netflix Continues to Shore Up Its Business
It took awhile, but NFLX stock is now genuinely profitable. International streaming is also finally profitable, to the tune of $227 million in contribution profit. NFLX stock has likely soared because investors feel good that NFLX has almost 53 million paid streaming memberships. That’s likely to continue to grow, even as NFLX gently raises prices from time to time. Some of the growth in streaming, though, comes from the 800,000 DVD subscribers they lose each quarter.
Mind you, the DVD business still accounts for a quarter billion dollars in profit, even as the number of memberships continues its 20% year-over-year decline to 3.33 million.
Netflix is persisting with its strategy of drawing down billions of dollars in fairly expensive debt and funding content with it. It doubled its debt load from $2.37 billion to $4.89 billion, which is costing it about $300 million in interest each year.
Thus, it is no surprise to find that NFLX burned through $1.78 billion in cash during the year, of which $488 million came in Q4. And that will get worse. NFLX says it will spend $7.5-8 billion on content on a P&L basis in 2018.
The Future for NFLX Stock
So, where does NFLX stock go from here? Its easy to say “up”, because the entire market is going that way and it just fuels interest in the FANG stocks. Am I being unreasonable by saying NFLX stock at 200x earnings is really nuts? What about at 10x revenues?
Amazon.com, Inc. (NASDAQ:AMZN) trades at 320x earnings but at only 4x revenues. Netflix has a larger library of original content, but that’s not enough for such a disparity in valuation.
What if NFLX, say, doubled its global subscriber base, and enjoyed 30% margins? That would take global revenue to $22.5 billion and operating income to $7.5 billion. What if marketing and other expenses were cut in half to a total of $1.6 billion? What if NFLX had to triple its debt to keep producing content, and interest expense rose to $900 milllion?
That would get Netflix to net income of $5 billion. And if NFLX stock went nowhere from here, it would trade at 23x earnings and 5x revenues. That would not be unreasonable.
What’s a Fair Price on NFLX Stock?
So, what would it take to get there? Domestic subscriptions are growing at 10% per year and are at 53 million. Thus, domestic doubling would take 10 years. International is growing at a 40% clip, down from 50% last year. Let’s say it goes to 20% next year, and holds at 20% per year thereafter. Getting to international peak would take about four years. Over the next six, NFLX could aim to raise average annual prices the $3.50 per month needed to equal US rates.
That’s obviously a quick and dirty calculation, and it assumes zero NFLX stock appreciation over the next ten years.
Which is a long way of saying that NFLX stock remains stupidly expensive and will not be reasonably valued until years in the future or a major correction brings the price in line with current realities.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
