- July 29, 2022
- Posted by: Ramkumar
- Category: Posts
Why Netflix Share Prices Crashed
Netflix share prices crashed after it reported a 𝐝𝐞𝐜𝐥𝐢𝐧𝐞 𝐢𝐧 𝐬𝐮𝐛𝐬𝐜𝐫𝐢𝐛𝐞𝐫 𝐚𝐝𝐝𝐢𝐭𝐢𝐨𝐧𝐬 last quarter. The company further forecasted the subscriber count to decline in the coming quarter and thus has looked at other avenues like advertising revenues to meet the growth targets.
There are 𝐭𝐰𝐨 𝐰𝐚𝐲𝐬 𝐭𝐨 𝐯𝐚𝐥𝐮𝐞 𝐍𝐞𝐭𝐟𝐥𝐢𝐱. One is the conventional DCF, and the other is to value the subscriber to arrive at the firm value. If your assumptions are correct, both the methods should yield the same number.
I decided to value Netflix by valuing its subscriber.
𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐚𝐬𝐬𝐞𝐭𝐬 = (𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐄𝐱𝐢𝐬𝐭𝐢𝐧𝐠 𝐒𝐮𝐛𝐬𝐜𝐫𝐢𝐛𝐞𝐫)* 𝐄𝐱𝐢𝐬𝐭𝐢𝐧𝐠 𝐬𝐮𝐛𝐬𝐜𝐫𝐢𝐛𝐞𝐫𝐬 + (𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐍𝐞𝐰 𝐬𝐮𝐛𝐬𝐜𝐫𝐢𝐛𝐞𝐫 * 𝐍𝐞𝐰 𝐒𝐮𝐛𝐬𝐜𝐫𝐢𝐛𝐞𝐫𝐬) – 𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐂𝐨𝐫𝐩𝐨𝐫𝐚𝐭𝐞 𝐞𝐱𝐩𝐞𝐧𝐬𝐞𝐬.
To value the existing subscriber, I assumed the following:
1)Netflix’s cost to service the subscriber = G&A Costs + 20% of Content costs
2)I assume the remaining 80% of the content costs are corporate expenses.
3)A Netflix subscriber’s lifetime period on the platform = is ten years
4)Renewal rates = 93%
5)Growth in annual subscription membership costs/yr = 5%
6)The growth rate in customer services cost/yr =2%
After ten years, the value of the existing subscriber becomes zero.
I get the value of the existing subscriber = $650.92
𝐕𝐚𝐥𝐮𝐞 𝐟𝐫𝐨𝐦 𝐭𝐨𝐭𝐚𝐥 𝐞𝐱𝐢𝐬𝐭𝐢𝐧𝐠 𝐬𝐮𝐛𝐬𝐜𝐫𝐢𝐛𝐞𝐫𝐬 = $𝟔𝟓𝟎.𝟗𝟐*𝟐𝟐𝟏.𝟕𝟒 = $𝟏,𝟒𝟒,𝟑𝟑𝟔.𝟗𝟒 𝐦𝐢𝐥𝐥𝐢𝐨𝐧
Costs/New Subscribers = Marketing costs/(2022 total subs – 93%*2021 Total Subs) = $84.92
Value/New Subscriber = $650.92 – $84.92 = $577.32
Value of Corporate drag = 80% of Content costs *(1-tax rate) discounted at Netflix WACC (6.76%)
𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐂𝐨𝐫𝐩𝐨𝐫𝐚𝐭𝐞 𝐝𝐫𝐚𝐠 = $𝟏,𝟓𝟔,𝟔𝟖𝟒.𝟏𝟗 𝐦𝐢𝐥𝐥𝐢𝐨𝐧
Current EV = $1,06,973.56
Value of New subscribers = EV + Value of Corporate drag – Value of Existing subscribers
Value of New subscribers = $1,19,320.80
Count of New subscribers = $1,19,320.80/$577.32 = 206.68 Million
𝐍𝐞𝐭𝐟𝐥𝐢𝐱 𝐧𝐞𝐞𝐝𝐬 𝐭𝐨 𝐚𝐝𝐝 𝐚𝐧𝐨𝐭𝐡𝐞𝐫 𝟐𝟎𝟕 𝐦𝐢𝐥𝐥𝐢𝐨𝐧 𝐬𝐮𝐛𝐬𝐜𝐫𝐢𝐛𝐞𝐫𝐬 to justify its current EV.
In my view, a few challenges for Netflix are:
1)If they increase membership costs, churn increases due to competition.
2)The TAM for OTT will not expand as the assumption that every content will move to digital is not realistic, and due to competition, Netflix will not tap this market share due to expanding TAM.
Thus, in my view, 𝐍𝐞𝐭𝐟𝐥𝐢𝐱’𝐬 𝐛𝐮𝐬𝐢𝐧𝐞𝐬𝐬 𝐦𝐨𝐝𝐞𝐥 𝐢𝐭𝐬𝐞𝐥𝐟 𝐢𝐬 𝐚𝐭 𝐫𝐢𝐬𝐤, and there are no networking effects that the firm will enjoy. So if Netflix has to achieve its growth targets, it either has to grow at the expense of margins or slow its growth.
Thus, Netflix’s decline in share price is not because it had a poor quarter but due to a 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐢𝐭𝐬 𝐟𝐮𝐧𝐝𝐚𝐦𝐞𝐧𝐭𝐚𝐥𝐬.