NETFLIX ANALYSIS (NFLX.) - Final Recommendations

Final Stock Examination:

Netflix has established itself as the clear market leader in the rapidly growing global streaming industry. Over the last five years, Netflix has demonstrated strong top line growth, doubling its subscriber base from 139 million members in 2018 to over 220 million by end of 2022. This exceptional user gain has driven consistent 20-30% annual revenue growth, with sales rising from $15.8 billion in 2018 to reach $31.6 billion in 2022. Netflix’s first mover status in directly offering unlimited on-demand video streaming has allowed it to scale well beyond media peers, cementing strategic positioning as the premier international entertainment platform.

However, cracks in the armor emerged in 2022 as Netflix experienced its first ever customer decline, losing 200,000 subscribers to end the year with 221 million members globally. While still the streaming market leader, this signals rising maturity in Western markets where streaming adoption appears saturated. Meanwhile, new offerings from Disney, Apple, Amazon and others have increased competitive pressures for consumer share of wallet. This will challenge the profit growth investors have become accustomed to, with operating margins falling from 13.1% to 10.4% in 2022 on rebounding content costs and foreign exchange headwinds. Can Netflix return to the days of 20-30% earnings growth as competition further intensifies? Ensuring global operating leverage on past infrastructure investments will determine profit trajectory.

On the financial position front, Netflix carries $17 billion of debt to fund rising content budgets in support of subscriber growth. While a sizeable obligation load, Netflix has taken a prudent, long-term approach structuring its liabilities. The majority consists of $14.4 billion in senior unsecured bonds, providing committed financing at fixed 3-6% coupon rates. By ladder maturing these public bonds across 2024-2030, Netflix avoids any near-term liquidity cliffs while aligning principal amounts with realistic scales of cash flow generation years into the future. Further, the unsecured, covenant-lite structure offers maximum strategic flexibility without restrictive lending terms that could inhibit growth.

Supplementing its bonds, Netflix holds $1 billion in undrawn revolver capacity allowing flexible access to working capital borrowing. Though currently untapped, this backstop liquidity combined with the laddered bonds significantly mitigates refinancing and interest rate risks compared to short-term corporate loans. Still, with negative working capital and more limited cash reserves than entertainment peers in recent years, shoring up liquidity positions and nurturing cash flow remain imperative to services debts. Content costs will need diligent oversight.

On balance, Netflix remains attractively positioned long-term in the streaming content race. Willingness to sacrifice near-term margins to invest aggressively in global subscriber reach for the future suggests Netflix is playing offense by prioritizing market leadership over profit maximization in these early, high growth years. Moreover, major technology bets on product innovation in areas like personalized recommendations, virtual reality and interactive content point to Netflix cementing strategic positioning as the next generation entertainment platform consumers gravitate to. These growth investments do pressure near term profitability - but they also widen Netflix’s competitive moat if successfully executed over 5-10 year timeframes.

Financially, prudent leveraging tactics aligned with long-run cash generation provide Netflix with committed funding to continue outpacing rivals on content budgets into 2030. Execution risks certainly exist, especially if subscriber growth fails to reaccelerate. Yet the underlying capacity to penetration global entertainment spend across both developed and emerging markets remains formidable.

Final Verdict: Despite some bumps emerging on the road to internet TV ubiquity, Netflix’s market leadership, growth orientation and financial construct keep its long-term investment case firmly intact. An upside target price of $472 seems reasonable based on free cash flow projections. Selectivity around entry timing can mitigate shorter term risks until consumer traction improves post-pandemic. So while short-term traders can opportunistically target lower prices through puts, the superior risk-reward likely rests with bullish investors accumulating shares during temporary, panic-induced declines. A buy and hold strategy is best the company's leadership position in the internet TV market, growth trajectory, and financial health offer superior long-term upside potential that is likely to reward patient investors handsomely over a multi-year horizon.

Why FCF was Chosen:

A free cash flow (FCF) model is well-suited to modeling Netflix's unique dynamics as a high-growth company undergoing disruption within the media industry. Specifically, the McKinsey FCF approach provides an analytical methodology for valuing Netflix by forecasting key drivers of free cash flow many years into the future.

By projecting long-term paid streaming subscriber growth, monthly revenue per user, content and marketing costs as a percentage of revenue, and assumed operating margins, the McKinsey model estimates Netflix's intrinsic value. The ability to continually grow global streaming subscribers is crucial within the projections. Even slight changes to assumptions around future subscriber growth rates or monthly fees per user can significantly alter Netflix's estimated intrinsic value by impacting projected free cash flows.

However, the actual market valuation at which Netflix trades also depends on broader investor sentiment, evolving consumer behaviors, competitive factors, interest rates, and qualitative risks. Small changes in perceived risks can drastically affect Netflix's realizable market capitalization, regardless of the technical intrinsic value estimate from the financial model. Therefore, while the McKinsey FCF model provides an analytical approach to valuing Netflix, management must also closely monitor industry dynamics. Specifically, risks around potentially slowing subscriber growth, thin operating margins, and heavy content spending requirements. The FCF model helps quantify upside and downside valuation scenarios based on different assumptions.

Alternative valuation approaches like market multiples or return on invested capital models oversimplify the complexity of financially projecting Netflix's industry disruption. By contrast, the McKinsey FCF methodology links directly to fundamental value drivers, allows flexibility to model uncertainty, and focuses projections on free cash flows that better capture Netflix's underlying business economics.

For these reasons, a FCF-based approach is most appropriate for modeling Netflix’s long-term financial outlook and estimated intrinsic value range. Management should combine the multi-year projections with broader awareness of competitive forces and investor sentiment around high-growth streaming and media stocks.

However, the McKinsey model has limitations despite its flexibility. As a forward-looking discounted cash flow methodology, the FCF approach relies heavily on accurately forecasting many fundamental assumptions years into the future. Small changes in projections around margins, subscriber growth, monthly pricing, or capital spending can radically impact the estimated equity value range.

Additionally, the model output is highly dependent on the terminal value calculation and long-term discount rate applied to aggregate free cash flow projections. Higher assumed terminal growth rates and lower discount rates used will increase Netflix’s valuation, and vice versa. Therefore, management must carefully sensitivity test all discounted cash flow inputs and assumptions.

The McKinsey model also focuses predominantly on fundamental financial projection and valuation, less so on evolving consumer behaviors, new competitors, differentiation, and qualitative risks that can disrupt industry economics. Management must therefore combine quantitative discounted cash flow analysis with broader strategic market awareness.

Other Opinions: NASDAQ.com

Summary:

Netflix’s battered stock price and elevated put premiums present an opportune short-term trading opportunity even while the company’s fundamentals show early signs of stabilizing. Technically, Netflix remains in a firm downtrend, having plunged over 60% from last year’s peak. This leaves the stock vulnerable to continued selling pressure or stagnation given unresolved overhangs around subscriber losses and margin compression. However, with puts implying further 10-20% downside, short sellers can collect rich premium income against limited risk. For example, the September $380 and $385 puts offer ~1% yields over just two-week durations. Annualized, these returns exceed 20-30% - attractive streams leveraging Netflix’s residual volatility as growth uncertainties linger.