Learning Resources

Investor Does Fundamental Analysis on Netflix (NFLX) - Stock Analysis For Beginners

31 Jul 2021

Transcript

00:00 About Netflix

Hey, I know your secret! I know many of you here are currently "working from home" but actually you’re just watching Netflix, right? No worries, I won't tell your boss because I also don't know who is your boss.

But anyway, did you know some people get paid to watch Netflix? The company hires people to tag or categorize shows and movies related to the content. Sounds interesting! Well, if you're interested, you can send in your resume.

Hey guys, I’m Alex. Welcome to Behind The Stock where I dissect company information and annual report to discover and identify investment opportunities for you. We upload new episodes every Friday! Make sure to subscribe and turn on the notification bell!

Now onto today’s episode, everyone’s favourite hobby - Netflix and chill!

Did you know that Netflix is technically older than Google? It was founded in 1997 while Google was founded in 1998. And before the company was launched, their beta name was Kibble. Yeah, like the pet food.

Other names they considered were Webflix, TakeOne and NetPix. But eventually, they settled with Netflix even though they didn’t like it. To this day, if you type in Kibble.com, it directs to the personal site of co-founder and first CEO of Netflix, Marc Randolph.

Back when Netflix was founded, it was during the VHS era. For those who don’t know, VHS looks a little something like this.

At that time, video rental stores were dominating the market. To watch movies at home, many would go to these stores, rent a few VHS tapes, and they have to come back to the store to return the tapes. And if the tapes are returned late, customers get charged a pretty high fee.

Netflix wanted to do things differently, so they began renting out DVDs by mail. It was a huge gamble because only 2% of the American households owned a DVD player at that time. The founders, Reed Hastings and Marc Rudolph knew if the market reached 20% of households, they would have a good business. It was a smart direction because eventually 95% of all households had a DVD player!

How their DVD rental worked was customers would select online and have it delivered straight to their doorstep. This was disruptive in the industry. A year later, Netflix introduced a subscription model where customers could rent DVD’s online for a fixed fee per month.

To this today, Netflix still offers DVD by Mail to customers in the US! In fact, there are about 2 million of them. Also, funny story, in 1998, the big historical moment in the US was the Clinton-Lewinsky scandal. All eyes were on President Bill Clinton. He admitted in a taped grand jury testimony about his affair with his intern at the time, Monica Lewinsky. Co-founder Marc Randolph wanted to offer something new to customers and made the grand jury testimony footage available for rental. BUT there were some mix up in the duplicating house. Out of 1000 customers who ordered Clinton's interview, a few hundred received discs full of Chinese porn. Urmmm, this one really Netflix and chill next level

03:03 Netflix Business Overview

Anyway, now let’s look at Netflix’s business today.

The Netflix business model is a platform that offers on-demand streaming of video for a subscription fee. An initial hook for potential customers is to offer one free month as a trial period.

Looking at this business model map, Netflix partners with content providers and pay them license fee in exchange for a variety of TV shows and movies to be on the Netflix platform. Besides that, Netflix also fork out productions costs to produce Netflix Originals. These are exclusive movies and TV series only available on Netflix. Then with all these content on the Netflix platform, they deliver to subscribers in exchange for subscription fees. They also collect data from their users to understand their behaviour.

The only source of revenue for Netflix is subscriptions. Netflix offers three different plans for users, Basic, Standard, and Premium. The costs of these plans differ in prices in different countries. The fees that they collect from subscribers go into investing into content. Netflix also raised capital through new debt issues to pump into content as well, whether through in-house production or license agreements with content providers. This is so that Netflix can have more content to grow their subscriber base.

04:20 Netflix Growth

Now, let’s look at Netflix’s growth.

During the pandemic in 2020, Netflix’s membership growth was off the charts! By the end of 2020, Netflix had 36.6 million new users. Just in Q2 of 2020 alone, they added 10 million new users. However, recent earnings show that membership growth could be slowing. Netflix reported they added only 1.5 million new paid memberships in Q2 2021.

In other aspects of growth, Netflix is looking at new markets and global expansion. The main driver of growth in the long term will be an active promotion in the Asian and Indian markets, which have significant potential. The company announced a USD 500 million investment in Korea and more than 40 new films and series in India.

Other than that, Netflix said they’re expanding into new genres and categories of content. So far, many have proved to be a success. In the first month, over 55 million household watched Shadow and Bone, a fantasy series based on a popular book series. It has been renewed for the second season.

Netflix’s expansion into non-fiction is also going well. Standout titles include Too Hot to Handle and The Circle, as well as the true crime docu-series, The Sons of Sam. Netflix is also quickly growing their live action and animated original films, working with big names in the industry. Zack Snyder’s Army of the Dead. Kevin Hart’s Fatherhood. And many more.

Besides that, Netflix is looking to expand beyond just film and TV by going into gaming! Netflix views gaming as another new content category which will be part of Netflix subscription at no additional cost to users. They’ll be primarily focused on games for mobile devices. This is building on Netflix's earlier efforts around interactivity. For example, the Black Mirror Bandersnatch special, You vs. Wild by Bear Grylls, and the Stranger Things games.

Eventually, the move may make it easier for Netflix to justify price increases in coming years. Netflix has hired former EA and Facebook executive Mike Verdu to be the vice president of game development. Since gaming is just a plan now and we can’t tell if it’ll be successful.

For Alex Meter, I say Netflix’s growth is so-so.

06:26 Netflix Moat

As for the strength or competitive advantage of Netflix, it is their product differentiation.

Aside from streaming content from third parties, Netflix also produce their own original and exclusive content. This strategy enables them to attract and retain customers. Netflix series accounted for 9 out of the 10 most searched shows globally in 2020. Meanwhile Netflix films represented two of the top 10.

Further proof that Netflix originals are popular, Netflix series and specials received 129 Emmy nominations! 24 nominations for The Crown, 12 nominations for Bridgerton, 18 for The Queen’s Gambit. Plus, Cobra Kai, Emily In Paris, and The Kominsky Method were all nominated for Best Comedy series.

For Alex Meter, I rate Netflix’s competitive advantage as good.

07:17 Netflix Risks

Moving on to the risk assessment of Netflix.

First is the intense competition. Netflix reported just under 4 million new subscribers in Q1 of 2021. This is well below their guidance of 6 million. Meanwhile in Q2, they brought in 1.5 million new subscribers. Just slightly above their guidance of 1 million new subscribers.

This puts Netflix on the lowest subscriber addition trajectory since 2013, which is when Netflix began producing original content. Netflix will continue to lose market share as more competitors enter the market especially peers with deep pockets like Disney and Amazon. For comparison, Disney+ expects to add around 35 to 40 million subscribers a year through 2024. Netflix will only add about 10 million subscribers per year through 2024.

Another risk is the low barrier to entry.

The streaming market now has at least 14 streaming services with 10+ million subscribers. Many of the competitors like Disney, Amazon, YouTube, Apple have other profitable businesses. Which means they can subsidize for the lower-cost streaming offerings.

This can permanently reduce Netflix's subscriber growth potential. Not only that, but this could also create pricing pressure on Netflix. Since Netflix only relies on subscription as a revenue source, it will impact the business profitably heavily.

For Alex Meter, I rate Netflix’s risks as mid to high risk.

08:40 Netflix Financial

Next, let's look into the financial of the business. In terms of the revenue and net income, it is growing strong with high and improving gross profit margin, net profit margin, and return on equity. However, it has a very high debt level at 1.29x total debt to equity ratio. In terms of cash flow, they only turned positive during this pandemic, which is a good thing. However, with the slow down in subscribers, I'm not too sure how sustainable the cash flow will be.

So for Alex Meter, I would rate Netflix’s financial as medium risk.

09:12 Likes & Dislikes about Netflix

Here’s what I like and dislike about Netflix.

What I like is Netflix’s direction of producing their own series and films to attract new users and retain existing ones. Many of these Netflix series and films have become cult favourites like Orange is the New Black, Stranger Things, Unbreakable Kimmy Schmidt, Squid Game and many more!

But that also brings me to what I dislike. Producing Netflix Originals require high CAPEX, which explains their high debt. Together with their slowing subscriber growth, it means these shows aren’t converting to sales. For example, one of the most expensive shows Netflix produced was Sense8. Experts estimated that Sense8 was costing Netflix $9 million an episode. Game of Thrones, HBO’s biggest series and one of its most successful, costs only about $6 million an episode. Games of Thrones could pull in 8.9 million viewers but Sense8 only to a niche audience.

Another thing I dislike is that many people can share one Netflix account. This is commonly abused by Netflix subscribers. There’s no restriction in place. One person subscribes, but the account is shared with girlfriend or boyfriend, parents, brother, sister, grandmother, grandmother’s friend, and so on. Since the only source of revenue for Netflix is subscriptions, this is not good!

Another thing I dislike is that there are many choices for consumers in terms of streaming platform, especially in the US. There are too many competitors in this industry. We can already see the negative impact from Netflix’s drop in subscriber growth. And they have no pricing power.

So, after watching my analysis, would you add Netflix into your watchlist?

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Till then, I’m Alex and goodbye!