Netflix’s audience is growing. But so is its debt.


Netflix, the video streaming juggernaut, is growing at an astonishing rate. And if you ignore the fact that it’s borrowing billions to fund that growth, the company is a classic success story.

His ability to expand his global audience is truly impressive. the last digits show that Netflix gained more than six million paid subscribers worldwide in the three months to September. That’s about 66,000 more paying subscribers everyday, bringing its total to more than 130 million.

The extraordinary growth of Netflix has turned the media landscape upside down and thrilled the stock market. Like my colleague, Edmond Lee, wrote, Netflix’s challenge has helped motivate, if not entirely cause, a series of mergers, acquisitions and realignments among giant corporations. Disney and Fox, AT&T and Time Warner, Comcast, Amazon, Apple, Google and more: all have had to respond, many by increasing their own TV and video spending.

Wall Street has embraced Netflix as one of the so-called Faangs – short for Facebook, Amazon, Apple, Netflix and Google (which trades as Alphabet). Tech titans have propelled investors to huge profits for much of this year.

With Netflix’s resounding success in forging – and, so far, dominating – the global video streaming market, it might seem rude to harbor doubts.

Still, Netflix poses a difficult problem for investors. All of these movies and TV shows are expensive, and in order to fuel its explosive expansion, the company has been spending faster than it’s taking in cash – and expects to continue doing so for years to come. Netflix built its business on a mountain of risky debt.

Despite this, the Wall Street consensus is bullish. The company predicts that within a few years, costs will begin to rise more slowly than revenues. In one conference call this month, David Wells, the company’s chief financial officer, forecast “material improvements” in 2020. “We still think it will take a few years to break even,” he said. Wall Street has largely accepted this forecast, expecting that at some point Netflix won’t need to borrow to pay its bills and profits will rise.

However, not everyone is convinced.

“Netflix’s fundamental business model seems unsustainable,” said Aswath Damodaran, a New York University finance professor who has taken a close look at the company’s numbers. “I don’t see how it’s going to be.”

With increased competition looming in video streaming, he said, Netflix must continue to spend huge amounts on content and marketing. If he cuts spending, he said, he risks losing much of his valuable audience.

“Of course the business is growing fast now,” he said. “It has an incredible number of new movies and TV shows. For a consumer, that’s fine. But for an investor, it’s a different story: the bigger Netflix gets, the higher its costs and the more money it burns. I don’t know how it’s ever going to change that. »

Professor Damodaran posted an evaluation model for Netflix on his blog, as an instructional tool. His model is based on a simple and well-established method — the discounted cash flow approach used by investment analysts around the world. At my request, he incorporated the company’s latest numbers into this model to determine what Netflix’s shares really seem to be worth. The results were surprising.

The company’s stock, he says, is only worth buying as a serious investment at around $177. But Netflix has been trading around $310 per share lately, after topping $400 earlier this year.

In a nutshell, the problem is the disparity between money coming in and money going out – and Professor Damodaran’s presumption that Netflix’s costs must remain high if they are to continue growing.

Netflix’s cash flow statement shows that in the 12 months to September, it spent $11.7 billion on new content. But its income statement shows total revenue was $14.9 billion, leaving it only about $3.2 billion to pay for marketing and the rest of its operations. It wasn’t enough to keep the business going, so the company borrowed money.

Monday, Netflix announcement that it intended to borrow more, selling $2 billion worth of bonds, which the rating agencies to say is below investment grade. This is on top of the $8.3 billion in speculative-grade debt already on its balance sheet. Borrowing is likely to continue to grow as long as the company burns through cash faster than its millions of subscribers are sending cash.

Professor Damodaran isn’t the only Netflix skeptic. In an Oct. 17 note to investors, Michael Nathanson, principal analyst at MoffettNathanson, said the company’s stock price was disconcerting and he believed a more realistic level was around $210.

Along the same lines, Michael Pachter, managing director of equity research for Wedbush Securities and a longtime critic, said he expects Netflix to continue to have trouble matching the costs and cash flow, given growing competition in video streaming – and the likely loss of movies and TV shows controlled by its competitors.

Disney and Time Warner (which owns HBO) are revamping their offerings. And Hulu (collectively owned by Disney and Comcast), Apple, Amazon and Google (which owns YouTube) are all serious adversaries now, he said. According to him, Netflix stock is only worth around $150 per share.

If Netflix were to fall anywhere near that level – losing half of its heartbreaking market value – its competing companies would likely be pushing ahead with their own streaming deals. Still, it wouldn’t be surprising if some of them — the recently merged AT&T-Time Warner entity, for example — wondered if their own marriages made much sense without the unintended influence of Netflix.

How worried should the stock market be about Netflix? He ignored those concerns for most of this year: From January 1 to July 9, Netflix shares returned a staggering 118%.

Since July 9, however, tech stocks have fallen and Netflix has been pummeled. Despite brief surges, its stock price has fallen more than 25% since that peak.

Netflix executives say they’re building their business for the long term. Last year, Reed Hastings, the company’s co-founder and chief executive, said he was not worried about traditional competition. Netflix was so compelling, he said, that his main opponent was sleep.

“You get a show or a movie that you’re dying to watch, and you end up staying up late at night, so we’re actually competing with sleep,” he said. “And we win!

In the latest earnings call, he said companies with deep pockets, like Disney, AT&T and Google, were real competitors. “One day there will have to be competition for share of wallet; we are not naive about it,” he said. “But that seems a long way from anything we’ve seen.”

Netflix, he said, must continue to “focus on our fundamentals” — providing viewers with engaging entertainment and delivering it in innovative ways.

But it will cost the company a lot of money. For consumers, this may not be a problem at all. Netflix has already made video entertainment far more plentiful and diverse than it was just a few years ago, and as more companies join the fray, the cornucopia of choice is likely to get even deeper.

But does that make Netflix great stock? You might want to look at the numbers carefully.


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