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Yesterday, Netflix reported strong earnings results, beating the consensus estimate by 14%. Revenues, net income, and total domestic subscriptions surprised to the upside as well.
Shares are up nearly 9% today, trading around $386.
BofA Merrill Lynch analysts Nat Schindler, Justin Post, and Jason Mitchell are among the most bearish analysts on Wall Street toward Netflix shares. They actually raised their price target on the stock after last night's earnings release — from $115 to $158 — but the forecast is still 59% below the current share price.
"Hard to find fault, but harder still to justify price," say the analysts.
In a note to clients, they explain their reasoning:
A valuation that is reaching “sky high”
With Netflix stock at $400 in the aftermarket, we find the valuation difficult to justify. In order to reach its current price, we believe the company would need: 1) total subs to peak at 140mn (70mn domestic, 70mn international); 2) prices to rise by at least $3/month per user; and 3) contribution margins to grow to 47% compared to today’s 24%. This bullish view is possible, but highly unlikely in our view given that it relies heavily on Netflix maintaining growth momentum even though Netflix has already penetrated 31mn of the ~100mn households in the U.S.
Raising PO to $158 based improved subscriber growth
We are maintaining our Underperform rating while raising our price objective to $158 (from $132) based on our sum-of-parts analysis at peak penetration. Our peak penetration rate has increased from 40mn to 50mn as we believe Netflix may be able to hold current subscriber growth rates for longer than we originally estimated. Our valuation analysis (see Exhibit 3 below) assumes that Netflix will reach peak penetration of 50mn households domestically in six years while hitting that same level internationally five years later. At peak penetration we believe the business should trade at an S&P multiple (15x) at best.
This bullish valuation scenario is based on a total subscriber base of 140mn with 70mn domestic and 70mn international subs. To reach these subscriber levels it would require an average annual sub addition rate of 5mn in the domestic business for 8 years and an average annual sub rate of 4.8mn in the international business for 13 years. In addition, subscription prices would have to rise by $3 and the effective contribution margin for both businesses would need to nearly double to 47%. We apply a 15x S&P multiple for steady state growth. Assuming no slowdown in sub additions for 8 years and high 47% contribution margins seems like a bit of a stretch, in our opinion.
Our $158 valuation is based on 50mn domestic and 50mn international subscribers. This will require 3.4mn annual average subscriber additions over 6 years in the domestic business (reasonable given the current 6mn sub add rate) and an average subscriber addition of 3.8 over 11 years in the international business. We assume no price increase for subs and have effective contribution margins of 35% for both businesses which should be achievable as Netflix leverages its subscriber base. We apply a 15x S&P multiple for steady state growth.
Netflix shares currently trade around 205 times trailing 12-month earnings.
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