Netflix: Great Company But Expensive Valuation

  • Netflix has announced a deal with Sony, which will give its subscribers access to Sony animation feature films.
  • The company is also on the verge of expanding into newer markets with a confirmed entry into six European countries and rumors of an entry into Australia.
  • The company’s strategy of content focus and geographic expansion drive the highly premium valuations.

Netflix valuation

Over the past week there have been a number of articles written about the rumoured entry of Netflix (NASDAQ:NFLX) into the Australian video streaming industry. Amidst all these rumours Netflix hasn’t lost its focus on content as it strengthened its content library with its newly announced deal with Sony. We think Netflix is right with the timing of its international expansion and its focus on content, which will help create long term value for its shareholders.

International operations close to break-even

The table below displays the operational performance of the international segment.

Netflix international operations

A look at the international operations performance over the last few quarters and management forecast for Q2 2014 suggest the current international operations are close to breakeven, probably expected to break even in the 2nd half of 2014. With the current international operations breaking even, they will be less of a drag on the company and could eventually support the expansion over the coming quarters.

The European expansion into six countries, covered in our earlier post on Netflix entitled Valuing Netflix International Business, couldn’t have been better timed. The company seems to have achieved a fine balance between cash flow, profits and expansion, something that is critical to maintain and easy to forget for a fast growing company. The European expansion will have a short term drag on the profitability due to customizing content for those markets and the content costs involved. However, a simultaneous expansion into Australia will not as exerting on the bottomline, due to the fact that the Australian market is a English content fan base, reducing the content costs to that extent. Hence, a simultaneous/closely following expansion into the Australian market may in fact be yet another good move by the Netflix management.

Variety and richness of content to appeal to all

Netflix has been a pioneer in bringing variety to its content library, through industry first deals with content providers like Time Warner, Disney, etc… The latest in its series of content boosting attempts is a deal with Sony Pictures for streaming animated films including Cloudy with a Chance of Meatballs 2 and The Smurfs. The deal will bring Sony pictures animation feature films on a first pay TV window to Netflix’s user base of over 36 million US subscribers.

According to a post on ValueWalk, Netflix has of late trained its content focus on acquiring kid’s related content acquiring rights to children focussed movies from DreamWorks animation apart from working on original content like crown. The focus on children related content will enable the company to acquire users who are likely to stay on with them as they mature and grow older. The company seems spot on with its demographics strategy.

Conclusion

Netflix is following a twin pronged strategy of growth through geographic acquisition and enrichment of content library through deals with content providers. The company seems to have hit the right balance between current operations and further expansion, which is a must for a growth company. Growing too fast can kill operations just as quickly as lack of growth and hence this balance is a valuable trait of the Netflix management. While this suggests a great company with led by a quality management, does it add up to a valuable stock? The stock is currently trading at a LTM price-to-earnings multiple of 157.08 and a price-to-sales multiple of 5.4, which makes it an outlier to the theories of value investing. Given the high growth priced into the current valuations, the risk associated with an entry into NFLX stock is extremely high and we would sit out of this one for the moment. See our top picks from the internet sector, which in our opinion, provide a better risk/return options for a value investor.

To see Netflix’s current stock price, please click here: (NASDAQ:NFLX)

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Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions. Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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