Given the plethora of data coming in from investment banks in recent weeks, it’s worth dedicating an article to a Netflix (NSDQ:NFLX) financial model overview. Some of my initial assumptions have changed, and to be more conservative I too am going to exclude China and India from my growth assumption to see how my estimate compares to other analyst models. I’m also truncating my figure from 2025 to 2020, so I can discount my assumptions under a relatively reasonable timeframe, and will offer my thoughts on valuation alongside some of the most relevant opinions from sell-side analysts.

123rf.com

There are some consistencies in the analyst views on long-term domestic U.S. subscriber figures by 2020. Analysts are anticipating Netflix to deliver at the low-end of the management outlook for 2020 (roughly 60 million), which makes sense given the number of users that share Netflix accounts and the negative household formation data among the millennial demographic. This basically implies that macro fundamentals will be supportive of less than 5.3 people per subscription, so this figure may improve assuming household formations improve, but I’m not getting aggressive here as the boomerang generation hasn’t done well economically, and was the lowest performing age cohort over a multi-decade span. I briefly discuss these demographic trends from Barclays data in a prior yet unrelated article.

At 4 users per subscription (given the way Netflix imposed limitation on combined usage) the number of users is likely to reach 240 million in the United States, which makes the audience comparable to linear television (data from Statista indicates 60% of the U.S. population has cable TV), hence Netflix is disruptive since it’s implied that among a 318 million U.S. population, roughly 75% of the U.S. population will likely have access to a Netflix account through household dynamics and sharing of services between multiple users. It’s likely that growth will taper off considerably beyond 60 million U.S. subscribers and ASPs (average selling price) will likely stay above $10 due to the adoption of 4K television sets and premium tiers provisioning for 4 continuous streams, which is necessary for users to share accounts. It’s worth noting that Netflix mentioned that there were 7 unique users per subscription at an AWS: Invent Conference, but with usage rates increasing I anticipate that users will want consistent access to their account given the limitations of four streams at the premium tier.

Here were some key comments from analysts in the past several weeks:

Based on our Global Broadband Rollout Analysis, we believe that Netflix can amass a global subscriber base of 180MM by 2020, assuming a range of adoption scenarios for each of its different markets, from 60% penetration in its U.S. to 15% penetration in its 2016 launch markets. There are a lot of puts and takes to this conclusion, but if we are reasonably accurate in this forecast, we see this leading Netflix to generate well over $10.00 in EPS in 2020. – Mark Mahaney from RBC Capital Markets

Based on our expectations for domestic streaming, DVD and international subscribers, and accompanying contribution margin, we continue to estimate Netflix EPS of $5.60 in CY20. Our 2020-year end subscriber estimate of 141M worldwide assumes 63% domestic and 10% international share of broadband subs. While this level of domestic penetration would be higher than any other comparative subscription entertainment product, we believe the content/value ratio offered by Netflix is, and will continue to be, higher than any other relevant comparative offering. – Michael Olsen from PiperJaffray

Usage per subscriber continues to grow in both the U.S. and overseas, which also suggests programming cost per hour of consumption continues to be stable-to-lower. Also, while recent press reports have suggested that Netflix has delayed its U.S. price increase, indications are that both the international and U.S. price increases are on track in terms of timeframe. Our base case scenario represents our bullish outlook for Netflix, as represented in our forecast: subscriber growth at a 21.1% CAGR through 2018, while also increasing ARPU at a 6.5% CAGR. We also expect Netflix to achieve a 14.8% EBITDA margin on a consolidated basis. – Doug Mitchelson from UBS AG.

There’s actually a lot of disagreement among the consensus on what average selling prices will be. While I have dedicated an extensive analysis on the feasibility dynamics in emerging markets, and recent satisfaction trends from various analysts. It’s not a completely reliable forward indicator, but it’s representative enough to provide context on emerging market adoption once Netflix scales its regional content offerings and provides infrastructure in the form of Content Delivery Networks (CDNs).

(Click on image to enlarge)

Source: Alex Cho

For the most part, I’m anticipating penetration dynamics to be roughly comparable to the mix assessment by RBC Capital Markets. After aggregating penetration data on fixed broadband from data sources like the World Bank and ITU, I have excluded the impact from China and India. Given the limitations of data speeds on wireless baseband, and data caps the TAM doesn’t expand as quickly with the exception of China as it’s heavily committed to fixed broadband build-out even in rural parts of China. India’s fixed broadband penetration sits below 1.5%, but I can imagine that figure expanding quite considerably, and I will publish my estimates on household broadband in a future article. Given my exclusion of India and China, my revenue estimate is above consensus at $20.05 billion by FY 2020. My estimate compares to Morgan Stanley, PiperJaffray and UBS at $15.54 billion, $17.19 billion, $21.121 billion respectively. RBC doesn’t project out to 2020, but they’re implying a figure above $18 billion when projecting 180 million+ subscribers.

(Click on image to enlarge)

Source: Alex Cho

I’m anticipating some expense leverage, and above consensus EPS in the current fiscal year. This is after assuming relatively aggressive expense ramp, and the leveling off of content costs given the full phase-in of Walt-Disney licenses. My EPS estimate is $0.71, which is above the consensus EPS estimate of $0.27. This is mostly driven by my revenue estimate of $9.1 billion for FY’16, which is above consensus estimates of $8.72 billion. I believe revenue will surprise this year given the phase-in of higher pricing on subscribers from 2014, which pushes my ARPU figure considerably higher. I also believe that the incremental revenue from that pricing increase adds significant expense leverage, and since Netflix’s content commitments are fixed for the foreseeable 12-months, the gross margin will likely expand whereas expense ramp for R&D and marketing will remain constant.

I’m fairly conservative on margins (analysts anticipate net income margins above 10% by 2020). I project GAAP $4.54 diluted EPS by 2020, and anticipate a net income margin of 10.46%. I arrive at a price target of $135.06 after discounting my end of five-year valuation of $206.69 by 8.83% (the firm’s WACC). Taking this into consideration, I still view Netflix as undervalued despite the heightened multiple it currently trades at. Since there’s a lot of forward looking bias to markets, I believe the markets will eventually value the firm at some sort of premium to 2020 earnings above $4.00, which is why the price is trending higher despite a forward P/E multiple of 97.73.

After revising my prior PT estimate from $133.42 to $135.06, not a whole lot has changed in terms of my value driven argument. However, there’s enough visibility into international subscriber ramp, and satisfaction trends to get incrementally aggressive. It also helps that the stock has sold off recently, which creates a compelling entry opportunity for both small and institutional investors alike. As such, I continue to reiterate my high conviction buy recommendation.