INTRODUCTION:

NFLX has come a long way since being rejected by blockbuster, its secret formula being the first to embrace change. It embraced DVD at a time where VHS was still the dominant mode of display. It embraced Streaming when the world started catching onto DVD. NFLX's edge was that it always pivoted quickly to the next big thing. But NFLX’s massive progress may soon grind to a halt. From lackluster solutions to strong competitors and pure market saturation, NFLX has a tough road ahead.

INVESTMENT THESIS 1:

Overblown Growth Solutions

When NFLX lost subscribers for the first time in 10 years, people freaked out and started selling off NFLX. But it seems that when NFLX announced its plans and after 1 successful quarter with some results from Ad-Tier NFLX bounced back up almost doubling from when it first dropped due to the shock.

Ad-Tier has some parallels to pirated sites. Both stream contents with Ads injected into the mix, either before the video plays or on the side of the screen. The main difference is that one is free and the other costs $6.99/month.

There are only so many people in the world that wants a YouTube equivalent as their streaming platform. The people who purchase Ad-Tier are usually “seasonal” fans, those that purchase cheaply so that they can watch their favorite series and unsubscribe afterwards. These subscribers have no longevity to them and temporarily bump up NFLX’s numbers.

Paid-sharing, getting people to get off shared accounts and getting their own accounts. Depending on how NFLX goes about it paid sharing could be a game changer for NFLX. There is already an existing customer base from those that are sharing account, they show a liking for NFLX but whether these customers will convert is dependent on certain factors Effectiveness of Paid-Sharing, ‘FOMO’ factor and Piracy.

Effectiveness of Paid-Sharing,
Is the net cast wide enough to catch all the paid-sharing users? What are the ways we go about catching Paid-Sharing?

‘FOMO’ factor,
Just how much are customers missing out will determine how they weigh the cost of monthly subscription and the ability to participate in the latest series.

Piracy,
Is it easy to find alternatives that can provide what NFLX provides for free?

INVESTMENT THESIS 2:

Strong Competitors & Lack of C.A.

The usual suspects obviously include DIS, Hulu and AMZN prime. But, what about the less obvious ones?

TikTok & Instagram reels. There’s only so much entertainment needed in one’s life. You can’t possibly simultaneously watch TikTok while watching a NFLX series, your attention can only be paid in one direction. (SOURCE)

Or AMZN with an all-inclusive ride on their AMZN prime with AMZN prime offering other benefits on their online retail store. They are “Offer-Stacking” creating an unbeatable offer that NFLX can’t counter.

DIS has a large vault of already created storyline that they have archived yet to be released onto Disney+ and the familiarity of DIS’ brand name enhanced by their theme park creates a very strong branding fit for the entire family that NFLX can’t parallel. (SOURCE)

NFLX has no differentiator other than it was the earliest entrant and is now the largest entrant. There are certain exclusive content on NFLX that may make it appealing, but these kinds of advantages are superficial and over the long run, these exclusive content may offer their rights to stream to competitors or may be pirated.

INVESTMENT THESIS 3:

Market Saturation

NFLX can only grow so much.

UCAN from FY21-22 only added 0.7M subscribers and LATAM added 3M. LATAM’s market was already said to be 75% penetrated by NFLX (SOURCE).

NFLX should focus on making its subscribers more valuable which management has said it will focus on now, but it has only so far laid out plans to attract new subscribers.

Even if Linear Network loses most of its grounds in the next 10 years, NFLX may not gain much subscribers from Linear Network simply because Linear Network is mainly supported by the exact demographic that would not be on NFLX.

REVENUE:

Model

I’ve used a bottoms-up approach when modelling my revenue and forecasted using historical data and surveys done.

Revenue/Subscriber

NFLX applies third degree price discrimination in how it prices subscriptions/month for different regions. Regions where it has already established a presence and where NFLX integrated into their daily life, NFLX charges a higher subscription/month.

But I don’t think every region will eventually tend towards the UCAN cost. Certain regions may see subscription services as a luxury good.

Overall, with the implementation and wide rollout of the Ad Tier I project my average revenue/customer to be higher for every region as the Ad Tier generates higher revenue per subscriber monthly, according to management.

According to 2021 US Bureau of Labor Statistics, an American with Annual income of $78,743 and expenditure of $66,928 spent 0.97% of that amount in entertainment and of that 0.97% only 18% goes towards “Fees and admissions” so about 0.17% of $66,928 went towards NFLX. $654 represented the annual spending on subscription services + others. NFLX takes up 30% of this, most households have more than 1 subscription. So, NFLX is probably tethering at the limit at which it can raise prices.

Comparing the cost per month of subscription between NFLX and its closest competitor DIS, Disney+ cost $4.80 compared to NFLX $15.86.

So, I forecast that the majority of increase in Revenue/Subscriber for the US will come from wider adoption of Ad-Tier subscription which yields a higher amount of Revenue/Subscriber rather than NFLX increasing prices.

European subscription is one of the highest cost to subscribe (SOURCE) so, I'd say its unlikely EMEA will raise monthly subscription cost but rather EMEA is the region with the highest likelihood to group subscribe to lower subscription cost. So EMEA is more likely to add subscribers than revenue/subscriber.

OVERALL, I assume that the full effects of FOMO for Ad-Tier will only show up from 2025 onwards.

No. of Subscriber

For Paid Sharing,
NFLX has stated that the potential market could be up to 100+M households. I do also believe that convincing people who were previously sharing accounts of purchasing their own account may take some time to catch on, as they will have large FOMO after being locked out of their old account and missing the latest shows. And since NFLX only intends on fully releasing Paid Sharing from 23Q2 onwards, I believe the substantial addition to subscribers will only show up from 2025 onwards with the FOMO effect in full and Paid Sharing being rolled out entirely.

For fall of Linear Network,

(SOURCE)

Almost 40% of Linear Network supporters are baby boomers. As the baby boomers age and decrease in numbers Linear Network will start losing its main customers, freeing up market share for NFLX to take as the younger generations start being associated with Streaming services, streaming will become the new norm.

BUT, this cultural change will be one that takes time. It will not show up to a substantial amount in the time period of my forecast. So I opt for more granularity.

REVENUE MODEL: [INSERT]

MARGINS:

The difficulty in figuring out margins is that there is no reliable historic data within the past 5 years. Margins were always extremely skewed by extreme conditions.

E.g. from 2019 to 2020 margins jumped from 12% to 18% due to covid accelerating the adoption of NFLX.
OR in 2021 the marginal cost of acquiring content wrt to revenue being generated was the cheapest of the past 7 years at $0.5836 per $1 of revenue generated. Likely because people were embracing NFLX as tech adoption was accelerated prior year, margins peaking only a year later.

So, cost is broken down into 3 categories (Acquisition, Marketing and (Tech & Dev + G&A)). Tech & Dev + G&A are lumped together for more granularity instead of inaccurate forecasts.

Acquisition

As NFLX transitions into subscriber retention mode rather than attracting subscribers it inevitably will spend more on making its services more attractive so that existing customers will face a higher “emotional” switching cost, so churn rate is lowered. But acquisition will continue to take the largest portion of cost.

Marketing

Eventually the NFLX brand becomes more well-known or integrated into people’s daily life that they spend less on marketing themselves and more on advertising new content. Marketing costs will start to tend downwards. BUT there must always be a baseline amount of marketing cost to advertise new content.

Tech & Dev + G&A

Tech & Dev + G&A is likely to remain elevated for the first few years as NFLX starts to roll out Ad-Tier and begin supporting a substantial amount of new subscribers from Ad-Tier. But eventually as the number of new subscribers dwindles down, NFLX gets more efficient and needs fewer employees. It will also implement new tech features e.g. AI tech support to lower the number of employees necessary. So at that point Tech & Dev + G&A will tend downwards.

COST MODEL: [INSERT]

COST OF CAPITAL:

Cost of Debt

RFR (3M Average) = 3.53%

Risk Spread (3M Average) = 1.71% (SOURCE)

Cost of Debt = 5.24%

Timing of Debt

[TABLE]

Weighted Average Timing of Debt = 1.57 Years.

MV Debt = 19225M

Cost of Equity

Market Beta = 1.27 (SOURCE)

Market Price(3M Average) = $341.52

Shares O/S = 445M

MV Equity = 151976M

4105.02 = [4.58% x 4105.02] x (1+5%) / (1+R) + ([4.58% x 4105.02] x (1+5%)) x (1+3.417%) / R - 3.417% / (1+R) ^2
R = 8.635%
RFR (US) = 3.417%
ERP = 5.218%

COE = 10.16%

Weightage

% Equity = 88.8%

%Debt = 11.2%

WACC

Corporate marginal Tax Rate = 21%

WACC = 9.49%

CONCLUSION:

Ultimately, I’ve valued NFLX at $174.62, I just don’t believe in how astronomical growth could be, with all the changes that NFLX has introduced into the company. I believe that NFLX has set their priorities wrongly and are focusing on the wrong things, Subscriber growth shouldn’t be the focus it should be making our subscribers more profitable. It’s a good sign that they started caring and innovating again. But at the current trajectory I just don’t see it working out.

DCF: [INSERT]