Wachiwit
Shares of Netflix (NASDAQ:NFLX) have been one of the worst performers, certainly of the big names out there, during the technology correction which started late in 2021. With shares peaking at the $700 mark late last year, they are down two-thirds to $220 at this point in time, but that is after shares have rallied some $60 dollars in recent weeks.
These are prices which we really have not seen since 2017 as investors are dealing with slower growth, price in multiple contraction, certainly as growth is rapidly slowing down with competition still increasing, but more so subscriber losses being witnessed for the first time in about a decade period of time.
In the summer of 2021, I concluded that I was not tuning in yet amidst slower growth, tougher competition, strong competition and a reopening of the economy. Slower growth was actually a key driver behind short term earnings growth, as I was very cautious at $500 per share at the time. This was a bit premature, but by now I am glad that I have erred on the cautious side last year.
Some Perspective
Like so many stocks, Netflix has been a key beneficiary of the pandemic as well, which makes it important to look what the base case performance of the business was. For the year 2019, Netflix grew sales by 28% to $20 billion, with operating earnings up a billion to $2.6 billion.
This translated into net earnings of $1.9 billion, for earnings just north of $4 per share, translating into a sky-high multiple at 85 times earnings with shares trading at $350 ahead of the pandemic. This valued the entire company at $168 billion, after pricing in $10 billion in net debt related to content spending, valuing the operations at around 8 times sales.
With 167 million subscribers across the globe, the company was already a huge force, and ahead of the pandemic, the company guided for 3 percentage points improvement in terms of margins, suggesting that earnings could show strong growth again in 2020. Driven by the pandemic, Netflix posted $25 billion in sales in 2020 with operating profits inching up $2 billion to $4.6 billion, as earnings rose to $6 per share. Shares however rallied to the $500 mark, as multiples remain nosebleed high around 100 times earnings.
The company added 4 million new members (on a net basis) in the first quarter, reported just 1.5 million additions in the second quarter, limiting growth a bit, as the 2021 results were set to improve as well. Earnings for the first half of 2021 already came in at the same levels as 2020, but that is not representative as costs were cut amidst the fact that simply fewer content could be produced as well as a result of the same pandemic.
With growth slowing, that was really what made me cautious as even $30 billion in sales and 20% margins resulted in a near 50 times earnings multiple, too high to create a beneficial risk-reward. Of course, there is the issue of multi-layered accounts, continued growth, and perhaps a move into games as potential drivers, as the contrary is the case as well as valuations were high, content liabilities kept increasing and competition was heating up.
Re-Rating
Since voicing a cautious tone at $500 a year ago, shares rallied to the $700 per share mark by November as shares fell to the low $200 mark in April, now having settled here for a couple of weeks. Third quarter results for 2021 were still solid, which drove shares to a high as membership additions rose to 4.4 million again and while this ticked up, and so did revenues (partially driven by price hikes), it were margins which were lagging.
In January 2020, Netflix posted fourth quarter results as additions of 8.3 million looks solid and were largely in line with expectations. This made that full year revenues rose to $29.7 billion as operating profits of $6.2 billion resulted in net earnings of $5.1 billion, equal to more than $11 per share. Shares fell to the $400 mark as technology valuations were already coming down as the company guided for soft first quarter net additions at just 2.5 million.
In April, shares fell to $220 overnight again as the projected net additions of 2.5 million were not delivered upon, in fact the contrary with the company losing 0.2 million subscribers during the quarter. Operating margins were sound in the quarter, but these are quite volatile of course, as the company guided for second quarter subscriber losses of 2 million members.
As it turned out in July, the losses came in at 1.0 million subscribers, a bit better than guided for, with year-over-year revenue growth slowing down to 8%, as quarterly revenues came in at nearly $8.0 billion, as the promising news is that third quarter additions are seen up by a million.
In terms of the financial performance, the company is generating some $32 billion in revenues and set to earn close to $6 billion per annum, with earnings trending at $13-14 per share here. That is a bit shortsighted as third quarter earnings guidance just north of $2 per share looks a bit soft, the result of slower growth and a strengthening dollar as well of course.
Concluding Thoughts
Right now debt is under control, ironically as slower growth actually helps near term cash flow conversion, but in the long haul we see pressure on the competitive positioning as the company is still in a content race, often against larger businesses which have core operations to funnel money into streaming services, like is the case with Walt Disney (DIS).
In the meantime, there are many moving parts with pressure on discretionary spending, competition and a fading pandemic being key headwinds. On the positive side is a near term tailwind from the hit Stranger Things, as it remains to be seen if and how password sharing will be addressed, and if it will have a net positive, or negative impact.
Needless to say, with current earnings power trending at $10 per share, or a bit higher, valuation have been derisked in a major way as a traditional 80-90 times multiple has fallen to 20-25 times here, making the backdrop a lot more interesting here, making it an opportune time to invest into Netflix, just like the rest of the technology sector here.
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