Netflix management has indicated that there is some seasonality to their growth. You can see that Blockbuster's Total Access program is really doing some damage to the growth of Netflix. Reed Hastings, CEO of Netflix, has indicated that he believes that Blockbuster's program is unsustainable, but he has reduced guidance based on the assumption that Blockbuster will not raise their prices for the remainder of the year.
As a starting point, I plan to use my adjusted owner earnings number of $67.7 million as noted above. If Blockbuster can sustain their prices, they may well outpace Netflix. This is a big IF here as Netflix has almost $400 million in cash, no debt, and a light business model. Blockbuster has $182 million in cash, $887 million in debt, and about 4,000 stores to pay for. I will grow Netflix's owner earnings at 5% for the first five years, 3% for five more years, and then use a reversionary P/E of 12. This results in a value of $13.50 per share. Add back their cash of $5.70 per share and the total value is $19.20 per share.
Based on the guidance that Netflix has given, their year over year growth this year will be approximately 11%. Keeping the same assumptions as above yields a total value of $20 per share. These seem to be the assumptions that the market is using to price Netflix shares.
If Netflix can keep up a growth rate of 12% for five years followed by 5% for five years and a reversionary P/E of 20, their total value is equal to $31 per share. None of these valuations take into account the large amount of free cash that could be moved from marketing to the bottom line. Netflix spent $225 million on marketing last year.
Netflix is currently priced as if their competition with Blockbuster will result in a permanent stalemate. With Movie Gallery's impending demise, Blockbuster may have more customers to draw in to Total Access, and more cash to continue their marketing push. I'm more skeptical of Blockbuster's longevity as a serious competitor. Beyond Blockbuster, though, there remains more competition for Netflix.
Netflix has shown some tremendous growth over the past five years, and they have a very light business model. Watch Now is just getting up and running, but showing some signs of success. There could be quite a bit of upside to Netflix shares.
I'm ambivalent about adding more shares for now. I want to see a couple more quarters from both Blockbuster and Netflix before I do anything. It feels too speculative right now. Maybe it is a calculated bet based on the cash Netflix has on hand. We may not know until the end of the year.