Netflix (NFLX, Financial) is the world's largest video streaming provider. The company reported strong growth during the lockdowns of 2020, as users were stuck at home and thus Netflix was an easy choice for entertainment. However, what this caused was a "pull-forward" in demand, so through 2021 and 2022, the company has faced a headwind from cancellations. Moreover, it is also facing increasing competition. Netflix ruled the streaming market alone for many years. However, in 2019, Disney's (DIS, Financial) streaming service Disney+ was launched and generated accelerated growth over the pandemic. Amazon (AMZN, Financial) also accelerated its video streaming offering, as did Apple (AAPL, Financial).
These dynamics caused a drop off in users, and Netflix’s stock price dropped by over 73% from its November 2021 high of $692 per share to its May 2022 low of $186 per share. Since that point, the stock price has rebounded by over 60%, as Netflix announced a number of sweeping changes to its platform to help bring back subscriber growth and improve profitability.
This includes the launch of an advertising service with partner Microsoft (MSFT, Financial). Its ad-supported plan was initially rolled out in Brazil, before being expanded across Europe, Japan, the U.S. and Australia.
I believe this is a positive strategy for the company as it offers an even more cost-effective plan at just $6.99 per month, which should boost subscribers while also diversifying revenue, especially in emerging markets.
Personally, I believe this could also act as a low-friction upsell to the company’s more expensive or standard plans. For example, once a user remembers how annoying ads can be when watching a movie, then I imagine many will upgrade for an extra $14.99 per month.
Netflix has also increased the price of its plans over the past couple of years. This highlights a competitive advantage for Netflix in terms of pricing power, which is especially important given we are in a high-inflation environment.
Improving financials
Netflix reported improving financial results for the fourth quarter of 2022. The business generated revenue of $7.85 billion, which was in line with analyst forecasts and increased by 1.9% year over year. Of course, this is not a fast growth rate for a growth company, but at least it's not a decline.
A positive for the company is on a foreign exchange rate neutral basis, its revenue actually increased by ~10% year over year, which is much more reasonable. The stronger U.S. dollar acted as a headwind for the company.
The good news is the currency markets tend to be cyclical by nature and the U.S. dollar has begun to correct down. In addition, the competition of Netflix will also face similar headwinds on international revenue.
In terms of subscribers, Netflix increased its subscriber number by 4% year over year to ~231 million paid members. Netflix has also announced even more plans to help get rid of sharing accounts, which would limit usage to only devices in a specific household location. The positive is this could help to capture a vast amount of "lost revenue" by encouraging those who were previously sharing accounts with other people to sign up. However, this strategy looks to have faced some backlash from consumers who say they would rather not have the account at all if they can't share it with family.
I believe Netflix is approaching the situation delicately and looking for ways to placate disgruntled customers. It is also still trying to find the best way to implement controls for when users travel.
The company reported operating income of $550 million for the quarter, which declined by ~13% year over year. In the earnings call, management blamed a huge $5 billion “non-cash” expense related to foreign exchange rates on its euro-denominated debt.
The good news is Netflix has a strong balance sheet with $5.15 billion in cash and cash equivalents compared to long term debt of $14.4 billion.
In terms of guidance for the first quarter of 2023, management has forecast between 4% and 8% revenue growth on a constant currency basis. This growth is expected to be driven by the adoption of the aforementioned ad-supported service and the elimination of shared accounts. However, growth is likely to be offset by the recessionary environment, which will likely mean advertising rates would be lower initially. In addition, new advertising platforms tend to take a period of time to “ramp up” in terms of inventory and targeting before they become real revenue drivers. Therefore I forecast Netflix to reap the major benefit of this near the end of this year or after.
Valuation
Netflix’s stock price has rebounded partially, but still looks to be undervalued in my view. For example, the company trades at a forward price-earnings ratio of 28.48 basd on earnings estimates from Morningstar (MORN, Financial), which is over 59% cheaper than its five-year average.
In addition, the company trades at an enterprise-value-to-Ebitda ratio of 0.5, which is ~53% cheaper than its five-year average and takes into account the debt of the company. The price-sales ratio is 4.53.
The GF Value chart indicates a fair value of ~$637 per share, making the stock look to be massively undervalued, though the system does indicate a possible “value trap" due to the declining earnings.
Guru investors
In terms of guru investors, Tom Russo (Trades, Portfolio) purchased 129,761 shares of Netflix at an average price of $280.49 per share during the quarter as per his firm's latest 13F filing. This level is approximately 15% cheaper than where the stock trades at the time of writing and brings his total position in the stock to over 1 million shares.
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
Russo is a highly regarded value investor and the founder of Gardner Russo & Quinn LLC. His firm's latest 13F recorded approximately $9.06 billion in stocks. Russo aims to identify companies with a “long runway” of growth ahead and a replicable business model. But more importantly, he also looks for companies which have the “ability to suffer” in which they can survive changing economic cycles.
Thus, I believe Netflix as a company embodies the type of businesses Russo looks for with its “strong brand” and growth potential ahead as more people “cut the line” on traditional TV subscriptions.
The world’s largest hedge fund, Ray Dalio (Trades, Portfolio)'s Bridgewater Associates, also doubled its position in Netflix in the fourth quarter and now owns ~84,422 shares of the stock.
Legendary trader Paul Tudor Jones (Trades, Portfolio) also increased his position in Netflix by 122% during the quarter, while Primecap management and Louis Moore Bacon (Trades, Portfolio) also added to their positions.
However, not every investor is buying Netflix. Activist investor Bill Ackman (Trades, Portfolio) famously announced the purchase of 3.1 million shares of Netflix on Jan. 26, 2022, before selling out of the stock just a few months later at an estimated loss of $435 million.
Ackman stated in a letter to shareholders he had “lost confidence” in the ability to predict the outcome of Netflix’s new business model. However, he did praise Netflix’s management team and their skillset. Ackman went onto say he would have “not be surprised” if management turned the company around.
Final thoughts
Netflix is a fantastic company that is still the market leader in video streaming. The industry is no longer a “one-horse race," but given how cost effective the packages are (especially with an ad-supported tier), I forecast positive prospects for the future. The company still has a long way to go, and it will be interesting to see how well (or not well) its password-sharing ban and other initiatives are responded to by consumers.
