Netflix Inc.'s (NFLX, Financial) stock has dropped by more than 7% in the past trading week after Chief Financial Officer Spence Neumann said its advertising revenue will take time to scale. According to Neumann, the company's password-crackdown initiatives have led to a plateau in platform traffic, concurrently adding obstacles to its advertising business.
Although Neumann believes the segment will eventually succeed, he thinks it will take time. After coming across Neumann's comments, I decided to assess the segment in further detail; here are a few factors that I picked up along the way.
A top-down analysis of its headline numbers
Recent data shows Netflix's market share in the streaming business is declining. On one side, much of the decline is owed to the natural development of the streaming industry's business cycle, which is consolidating. Thus, one could argue that the lower market share is normal for a "low barriers to entry business."
However, a contrasting argument is competitors have upped the ante, providing better content and subsequently nibbling away at Netflix's market share. I base much of the argument on anecdotes as I have realized that the company's content variety is stagnating.
Source: Similarweb (Netflix market share 2023)
Growth opportunities
Although Netflix is struggling with receding market share, it must be considered that the streaming industry remains in secular growth territory, with compound annual growth of 18.45% anticipated to last until 2030. Moreover, the company is taking advantage of ex-U.S. revenue, with only 40% of its trailing 12-month revenue stemming from the U.S., providing it with diversification benefits and renewed growth opportunities.
An abundance of opportunities exists within emerging markets as purchasing power-based pricing has led to a surge in streaming activity. In my view, emerging markets present a phenomenal opportunity for Netflix as emerging markets are gaining ground on the global gross domestic product mix.
Source: International Monetary Fund
An idiosyncratic vantage point
A quantitative measure of Neumann's claims shows Netflix's year-to-date traffic has flatlined significantly. Although the flatlining can partially be attributed to other factors, such as the back-to-office landscape and a softening economy, it is no coincidence the plateau occurred during the same period as the company's password crackdown initiatives.
Source: TipRanks (Netflix traffic)
Subscriber growth
Fortunately for Netflix, its paid subscribers have increased year over year, providing its subscription business with the necessary latitude to perform. I believe this somewhat contradicts Neumann's claims that a shakeout of subscribers is unfolding. Even though net usage and revenue have softened, the fact remains that paid subscriber support is robust.
Source: Netflix's second-quarter earnings results
Operating profit margins
Lastly, I felt it was necessary to mention that Netflix is set to recover its operating profit margins. The company is regaining demand in the labor force, meaning a plateau in the economy has transferred wage demand from employers to employees. Moreover, its restructuring has shown to have an immediate effect, ramping up Netflix's operating profit margin, which I believe will be sustained unless a structural break occurs within the company or its industry.
Collectively, Netflix's bottom-up features juxtapose its top-down attributes, illustrating that robust financial growth is present, somewhat phasing out its fight for market share.
Valuation
Netflix's secular fundamental growth and high price multiples suggest it is still a growth stock. As such, I decided to focus on growth-orientated metrics instead of mean-reverting price multiples.
As illustrated below, Netflix's Ebitda per share is on an exponential growth trajectory, which is encouraging to see. The Ebitda line item speaks volumes for technology companies as they often possess subjective depreciation and amortization policies. Moreover, the line items phase out volatile capital structures, which are inherent traits of growth-stage companies.
Forward rate of return
Another factor to consider is Netflix's Yacktman forward rate of return, which is an earnings-based expected return formulated for growth stocks. The company's forward rate of return is within the 72nd industry percentile, suggesting it possesses relative value.
Guru trades
Unfortunately, Netflix's guru trades index is in a year-to-date deficit, with the likes of Ken Fisher (Trades, Portfolio), George Soros (Trades, Portfolio)'s firm and Ray Dalio (Trades, Portfolio)'s Bridgewater Associates all disposing of its shares. Although the guru trades index is an isolated observation, it holds substance as it tracks the outlook of some of the most renowned investors around the globe.
Final word
An in-depth analysis shows Netflix's market share is waning, which has scared many of Wall Street's top-tier investors. However, an enhanced analysis illustrates that much of its password crackdown-induced market share decline has been phased out by robust idiosyncratic performance.
Further, the company is aligned to take advantage of opportunities in emerging markets, presenting a case for renewed growth.
Finally, Netflix's salient valuation multiples indicate the stock is undervalued. Therefore, I believe the asset will discover new horizons if provided with the necessary support from market sentiment.
