Netflix still has room to run

Think the Internet streaming giant is flying too high? In fact, shares are still trading near the midpoint of historical media valuation levels.

By Apr 25, 2013 3:15PM
Watching television copyright image100, CorbisA little over a year ago, I was ruminating about Netflix (NFLX) and using it as a tutorial for valuation (see Minyanville). At the time, the stock was trading in the mid-$70s on its way to $129 before retracing back to the mid $50s, and I had calculated that a reasonable target of over $100 was achievable. 

Here we are 15 months later with the stock trading at $216, which forces the question: Is today's price justifiable? In a word, yes. Here's the logic.

Currently Netflix has approximately 30 million U.S. subscribers plus an additional 7 million subscribers outside of North America, which puts the company on track to achieve 45 million by year-end.

Assuming an average monthly $10 ARPU (let's keep the number simple) results in $450 million of projected revenue per month, or annualized revenue of $5.4 billion by year-end, applying a traditional 25% EBITDA margin (a normalized cable television network margin) suggests normalized EBITDA of $1.350 billion or projected pro forma forward EBITDA of $22.50 per share.

Currently the company has an equity capitalization of $13 billion and net cash of $514 million, resulting in a total enterprise value of  $12.5 billion (the equity value less the cash), which, when divided by estimated  future EBITDA of $1.35 billion, suggests a rather ordinary 9.25 TEV/EBITDA trading multiple.  

As most media companies trade in a range between 8 to 12 times, this is not an outlier; given the company’s competitive positioning and focus, there is every reason to believe it could trade up to the higher end of the multiple range. A little math (12x 22.50 + 514/60) puts that target above $270.

Can the company achieve $1.35 billion in EBITDA? 

Adding back the approximately $500 million of content amortization reported in the first quarter to the $31 million in operating income and annualizing that number actually puts the company on track to generate an annualized run rate EBITDA of over $2 billion -- so yes, Netflix has some room to run.

But what about investment in content and the deleterious impact on earnings? For the period, investment in content exceeded amortization by approximately $88 million, and it is likely that the company will continue to expand its production as its primary use of cash. But over time as the self-produced library continues to grow and the life of individual projects lengthens, margins expand, providing confidence in the company’s ability to achieve the targeted 25% pro forma margin articulated earlier.

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