Big-Tech Investment Series - Netflix

Do all things without complaining and disputing, that you may become blameless and harmless, children of God without fault in the midst of a crooked and perverse generation, among whom you shine as lights in the world, holding fast the word of life, so that I may rejoice in the day of Christ that I have not run in vain or labored in vain.

Philippians 2:14-16

These Bible verses hit home for me. Far too often I am quick to complain, moan, or begrudge a situation. The fact is that we are all created by God and imperfect. And taking things or making things personal never accomplishes anything. Like Jesus, I must proclaim God’s truth so that others can find peace and truth through Him. This also hits home for how retail investors face extreme challenges from Wallstreets tactics. Instead of complaining and contesting what Wallstreet controls, investors are better suited to understand situations and manage expectations and areas where they have discretion.

The next company in the Big-Tech investment series is Netflix, Inc. (NFLX).

Key Takeaways for Retail Investors

• Wallstreet is focused on NFLX becoming a growth-by-acquisition company ala Microsoft Corp. (MSFT); NFLX doesn’t have the cash-cow of MSFT and acquisition integration risks, or no acquisition moves over the near-term may shift Wallstreet’s appetite.

• Cash flow instability will continue for NFLX over the short-term and if the company’s operating cash flow drops sub-15 percent, valuation multiples will likely contract.

• Risk reward is the most imbalanced out of Big-Tech options and investors keen on this group can find much better options elsewhere.

• NFLX is part of Big-Tech but stands out as the most vulnerable short target as it likely won’t get to the trillion level for enterprise value.

Like Apple, Inc. (AAPL), NFLX is arguably overvalued. When it comes to Big-Tech, my position is that NFLX is the most egregiously overvalued of them all. A companies’ rate of revenue and cash flow growth typically drives valuation levels and a company like NFLX can arguably have a premium versus peers like Comcast Corporation (CMCSA) or the Walt Disney Co. (DIS) even though it’s more diversified beyond streaming. However, the problem with NFLX is that its revenue growth is slowing and while cash flow inflection has occurred, future cash flow margins will likely see some shifting before investors can get a sense of where things stand.

Before we get deeper into NFLX’s cash flows, it’s important to recognize that the biggest driver of cash flows for the company is net income. Accordingly, NFLX has seen increasing improvement for its net income, but it wasn’t until the COVID-19 pandemic that the transition to operating cash flow inflection began to occur.

This is clearly the case. Since 2014, NFLX’s trajectory of cash burn was on a downtrend hitting a low point by 2019. This all changed during 2020. Understanding the key catalyst of the transition during the pandemic is important for investors to think about NFLX’s future and valuation.

During 2020, NFLX witnessed a first-time drop in additions to content assets stemming from stoppages in content production that was a core impact for media and entertainment industries during the pandemic. Despite this drop, amortization of content assets continued to increase, due to the lag effect of content spend and amortization of this spend, which ultimately led to NFLX’s first post-streaming business model operating cash flow year.

During 2021, NFLX saw a substantial increase in net income, but additions to content assets increased at a much higher rate than amortization as ‘catch-up’ production work materialized. During 2022, amortization caught up further, and in 2023 with the Screen Actors Guild strike, NFLX’s operating cash flow peaked at nearly 22 percent as another pandemic-like event allowed for stoppages in content production. If not for these two events, NFLX’s revenue and operating cash flow performance would look entirely different.

Another important way to consider NFLX’s cash flow performance is net results by content assets, reconciliation changes, and working capital. Working capital is the most negligible, and clearly, it can be seen how 2020 and 2023 really benefited NFLX’s cash flows. Through 2024 and on a year-to-date, or YTD period, NFLX has seen a reversal back to negative performance, albeit on a much more modest level.

All NFLX’s current revenue is derived from streaming across United States and Canada, Europe, Middle East and Africa, Latin America, and Asia-Pacific global markets. Average paying memberships have grown at an annualized rate of 13.5 percent since 2018. Average revenue per paying membership has increased by 2.2 percent accordingly. Estimates over the next five years are for NFLX to see this combined 15.7 percent rate of growth drop into the single digits.

Today’s operating cash flow margin near 20 percent is not sustainable in my opinion as I expect NFLX’s content spend to increase. NFLX may be able to mitigate this to a degree if paying members can continue to be ‘wowed’ by what NFLX generates. Recent sports deals have generated some additional buzz. Reed Hastings desire was always to become the streaming version of HBO, and he has succeeded in leading the global subscriber market while creating a virtuous cycle of exclusive content. For this reason, I’ve tried to be conservative in still affording NFLX an operating cash flow margin north of 15 percent.

In any case, even if NFLX retains a 20 percent cash flow margin, there is a strong case suggesting its valuation level cannot be maintained.

Final Thoughts

I’ve modeled NFLX to generate towards $55 billion in revenue by 2028 including close to $9 billion in operating cash flow. With share count assumptions, the only question for investors is the valuation multiple that should NFLX trade at. Aside from Rumble, Inc. (RUM), NFLX’s peer group average current and two-year enterprise value to sales multiple stands at 1.8 and 1.7 times versus NFLX’s 10 and 9 times. For operating cash flow, NFLX’s peer group average stands at 20 and 10.5 times versus NFLX’s 49 and 47 times.

NFLX is priced too rich and even with a 5 times enterprise value to sales and 30 times operating cash flow per share ratio and considering my model’s revenue and cash flow estimates, NFLX would generate an annualized return of negative six percent through 2028. If there’s one thing that is certain, it is that NFLX will not be able to sustain current and two-year multiple valuation levels. Retail investors should be on the lookout for Wallstreet’s pressuring tactics to encourage NFLX to start making acquisition moves to continue to inflate NFLX’s valuation as the alternative of slowing revenue and murky cash flows for the streaming business has today’s stock price on thin ice.

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