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Why Should We Invest? Netflix, Inc., incorporated in August 1997, is an online movie rental subscription service in the United States, providing approximately 7.5 million subscribers access to approximately
Competitors are FAILING while Netflix is THRIVING
Current growth stock poised for future growth based on technological innovation
90,000 digital versatile disc (DVD) titles plus a growing library of more than 6,000 choices that can be watched instantly on their
personal computers (PCs) and returned at their convenience
using its prepaid mailers. Subscriber information:
12/31 /31/08 /08
3 M o n t hs hs E n d e d
Consistent , sustainable growth Scalable business model – as subscribers grow, the bottom line will increase
09/30 /30/08 /08
Subscribers: beginning of period
8,672
8,411
Gross subs cribers cribers add itions: during during pe riod riod
2,805
1,528
Gro s s s u b s c rib er a dd it ion s y ear-t o -y ear ch an g e
39.5%
17.8%
Gro ss ss s ub ub sc sc ri rib e err a d dd d it it io ion s q u ua art er er-t oo-q u ua art er er s e eq qu ue en ti tial ch a an ng ge e
36.5%
10.4%
Les s s u b s crib er ca nc ellat io n s : d u rin g p eriod
(1367)
(1,267)
Subscribers: end of period
9,390
8,672
Sub s c ribe rs ye ar-t o-ye ar ch an g e
25.6%
23.4%
8.3%
3.1%
Sub s c ribe rs qu a rt er-t o -q ua rt er s e qu en t ial ch an g e Free s u b s crib ers : en d o f p erio d
226
Paid Paid s ubscribers year-to-year change Paid Paid s ubscribers quarter-to-quarter sequential change A v era ge mo n t h ly re ve nu e p er p ay ing s u b s crib er
$
Subs criber acqu isition cos t
(in 000s, except eps) Revenues Operating Income (EBIT) Net Inco me EPS Basic Diluted
8,490
25.1%
24.0%
7.9%
3.1%
13.58
$
$
26 26.67 .67
$36.17
Market Cap
2.13B
Beta
1.11
52 Week Range
$17.90-$40.90
P/E
27.28
P/S
1.8
13.60 4.2%
$
NFLX
Price
2.1%
9,164
4.2%
Churn
Ticker
182
2.4%
Free subscribers as percentage of ending subs cribers cribers Pa id s u b s crib ers : en d o f p erio d
Ticker Summary:
Bu 1 000 Shares
32.21
FY200 5A $ 682,213 $ 2,622 $ 41,889
FY2006A $ 996,660 $ 65,218 $ 48,839
FY2007A $ 1,205,340 $ 91,773 $ 66,608
FY2008A $ 1,364,661 $ 121,506 $ 83,026
F Y2009E $ 1,364,661 $ 178,941 $ 116,646
FY 2010E $ 1,364,661 $ 244,330 $ 157,839
FY 2011E $ 1,364,661 $ 316,976 $ 203,656
FY2 012E FY2013 E $ 1,330,544 $ 1,297,281 $ 377,081 $ 437,251 $ 241,761 $ 280,086
$ $
$ $
$ $
$ $
$ $
$ $
$ $
$ $
0.78 0.64
0.78 0.71
0.99 0.97
1.36 1.32
1.91 1.86
2.59 2.51
3.34 3.24
3.97 $ 3.85 $
4.59 4.46
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Table of Contents Company Overview…………………………………………………………………………………………………………………… 3 Competitors………………………………………………………………………………………………………………………………4 SWOT Analysis…………………………………………………………………………………………………………………………..5 Industry Outlook………………………………………………………………………………………………………………………..6 Investor Relations ……………………………………………………………………………………………………………………..8 Financial Ratios………………………………………………………………………………………………………………………….9 Pro Forma Income Statement ………………………………………………………………………………………………….12 Relative Valuation……………………………………………………………………………………………………………………13 Discounted Cash Flow Valuation ………………………………………………………………………………………………14 DCF Assumptions……………………………………………………………………………………………………………………..15 Final Points and Recommendation…………………………………………………………………………………………..16 Financial Statements ………………………………………………………………………………………………………………..17 Appendix…………………………………………………………………………………………………………..…………………….21 ValueLine …………………………………………………………………………………………………………..……………………2 2
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Company Overview Netflix is the largest online movie rental service operating in the United States with over 100,000 titles. They have both a physical rental service in which DVDs or Blu-Ray discs are mailed to the customer and an online video streaming service with roughly 9.4 million subscribers. 1 As a subscriber, you have access to both services under the same fee. Subscription Plans
Plan
Rentals/Month
Price/month
1 DVDs at a Time 1 DVDs at a Time 2 DVDs at a Time 3 DVDs at a Time 4 DVDs at a Time 5 DVDs at a Time 6 DVDs at a Time 7 DVDs at a Time 8 DVDs at a Time
2 Unlimited Unlimited Unlimited Unlimited Unlimited Unlimited Unlimited Unlimited
4.99 8.99 13.99 16.99 23.99 29.99 35.99 41.99 47.99
Online Streaming Hours 2 Hours Unlimited Unlimited Unlimited Unlimited Unlimited Unlimited Unlimited Unlimited
DVD/Blu Ray Rental
As a customer, you create a queue of movies/television DVDs or Blu Rays in the order you would like them sent to you. Netflix when then mail you the movies. Once you are finished with them, you reseal them in the prepaid envelope and drop them in the mailbox. If you drop the discs in Monday, you will most likely have your next videos on Wednesday. Blu Ray Discs are also available and can be accessed by any plan by being charged an additional $1 per month.2 Online Streaming
Netflix currently has over 12,000 titles available in their watch instantly service. The consumer can watch an unlimited amount of content instantly on all plans except the cheapest one. This section is also continuing to grow daily. The consumer can watch content on his or her computer or on a television via a variety of devices outlined in the Appendix. Furthermore, as time goes on, it is very likely more and more Blu Ray Disc players and digital video recorders will come with the Netflix streaming service built in.
1
Netflix 4th Quarter 2008 Earnings Release 2 Netflix.com 3|Page
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Competitors
Blockbuster Inc. (BBI): Blockbuster Inc. is headquartered in Dallas, TX and was founded in 1982. Blockbuster Inc. operates approximately 7,500 franchised video rental stores internationally and is the largest video rental chain in the United States. They rent and sell movies, video games, and entertainment related merchandise through their franchise stores and website. The company has several subsidiary brand names and concepts, including Game Rush stores in Canada, Mexico, and Italy and Xtra-Vision stores in Ireland. Blockbuster reported a negative 85 million dollar net income loss as of Jan. 6th, 2008. ( Reference Appendix 1 for prices)
Movie Gallery , Inc. (MVGR.PK) : Based out of Wilsonville, Oregon , Movie Gallery inc. specializes in home entertainment, specifically movie , video game , and DVD/ Blu-ray rentals. Movie Gallery is the 2nd largest video rental store in the US and has several subsidiary brands, including Hollywood Video, Movie Gallery, and Game Crazy stores. There are approximately 3,290 retail locations operated under the aforementioned brand names in North America today. Each brand focuses on enhancing the customer experience through exceptional customer service and creating a unique venue to buy, sell, and exchange movies/video games. It is important to note that Movie Gallery filed for Chap. 11 bankruptcy as of Oct. 16 th, 2009. Movie Gallery stores reported a 623 million dollar loss Jan. 6 th, 2008. This can be attributed to an out of control cost structure and outdated business model.
Redbox (Private): Redbox automated retail LLC is a leading retailer/ renter of DVD’s through their automated Kiosk’s located at McDonalds, Wal-Mart’s, and over 12,000 retail locations. Their business model emphasizes low-cost DVD rentals ($1) and the convenience of redbox by being able to drop off redbox movies at any location across the U.S. Redbox also allows customers to reserve and return movies through their website, redbox.com.
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SWOT Analysis Strengths
First Mover’s Advantage – Netflix essentially created online move rental
Rated #1 in online retail customer satisfaction by independent surveys from Nielsen Online.
True “No Late Fees”
Ability to recommend future movies using proprietary software based on the user ’s movie preferences.
Intuitive queuing system allows to users to create long lists of movies to be delivered in a particular order
Able to provide over 95% of t heir subscribers with 1-day delivery due to their 100+ shipping points.
Netflix continues to grow net Income and revenues while competitors are near bankruptcy
Netflix has around 75% of all online movie subscribers.
Weaknesses
People like being able to go in the video store and get their movies.
Consumer Discretionary - people might stop renting movies or cut back on rentals
No Games. For people who have kids or just people who play video games, the fact that Netflix does not offer video games could be a little bit of a turn-off since they would still have to go into a blockbuster to rent their games.
If an unlimited subscriber is turning over their DVDS fa st enough Netflix will lose more on delivery costs than they make on subscription costs, however this is extremely unlikely.
Opportunities
Online Streaming opens access to potential new customers
Netflix has deals with companies to be able to stream Netflix through the devices to the T V automatically and the potential to work out more deals
They offer a full Blu-Ray selection while Blockbuster and other competitors do not. DVD rentals are approximately a $9 billion business and Netflix is poised to gain more market share as more people move to online movie rental
Threats
Video on Demand services that many ca ble companies offer
Apple and Amazon are also offering acc ess to movies online.
Redbox and other automated kiosks are stealing customers from both video stores and Netflix.
A price drop in online movie rentals by competitors. could steal customers
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Industry Outlook: Looking at the video rental industry, it is important to examine the relative market share of each competitor. Of the estimated 9.5 billion dollar rental market 3 for video/DVD, the following companies dominate the movie rental industry landscape: Year
BBI
NFLX
MVGR
Total Mkt Size
‘08
5,542,400 5,523,000
1,364,000 996,000
2,452,442 2,541,930
9,358,842 9,060,930
‘06
'08 Relative Mkt Share
'06 Relative Mkt Share
MVGR 26%
MVGR 28%
BBI 59%
NFLX 15%
NFLX 11%
BBI 61%
It is clear that Netflix is encroaching upon and cannibalizing market share. Both Blockbuster and Movie Gallery have suffered at the hands of Netflix. Despite sluggish revenue growth, a closer examination of NI and subsequent store closures yields some insight into the antiquated business models dragging BBI and MVGR down.
Year
BBI
NFLX
MVGR
Net Income
‘08
-73,000
83,000
-622,398
Net Income
‘06
50,500
49,082
-552,000
*Values in Millions of US ($)
3
Constructed from Annual Sales Revenues of BBI,NTFLX, and MVGR , the 3 largest video rental companies in the US 6|Page
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BBI MVGR
Store Fronts as of 2006
Store Closures 4
8360 4430
(530) (940)
Total Stores in Operation as of 2008 7830 3490
The brick and mortar video rental store may be out of date. Movie Gallery Inc. filed for Chapter 11 bankruptcy as of Oct. 9 th, 2008, struggling under the burden of a heavy debt load and will close over 520 stores in restructuring efforts. 5 It is clear that there will be considerable opportunity for Netflix if MVGR stores continue to remain unprofitable. Blockbuster has also recently closed an additional 530 unprofitable store fronts, representing about 6 % of its revenue base. 6 The void created by additional store closures will undoubtedly benefit Netflix, especially in smaller communities. The yoke of the brick and mortar store front may be too unbearable for both BBI and MVGR to overcome.
Industry Metrics – Netflix:
7
‘08
‘07
‘06
‘05
Churn
4.20%
4.30%
4.10%
4.50%
Subscriber Acquisition cost
$26.67
$40.88
$42.96
$38.77
Netflix has managed to keep its turnover from subscribers relatively low while managing marketing costs. Blockbuster recently started its TOTAL ACCESS program to compete with Netflix’s unique offering and Movie Gallery has no such service. Consequently, there is no information on churn or acquisition costs for BBI or MVGR. In summary:
Netflix scalable business model should equate into lower costs and greater economies of scale as more subscribers opt to sign up for Netflix.
Store closures by BBI and MVGR will result in additional revenue and greater market share for Netflix.
BBI and MVGR may not be able to shed the yoke of their brick and mortar stores and effectively compete with Netflix in the coming years.
4
2007 Blockbuster Annual Report, http://www.costar.com/News/Article.aspx?id=9B6C725676E6A7711B4919E137DB5373 5 http://www.msnbc.msn.com/id/21324720/ 6 http://www.alleyinsider.com/2008/3/blockbuster_q4__not_too_bad__blockbuster_future__not_so_good__bbi_ 7 Churn = customer cancelations/sum of gross subscribers + additional subscribers /3 months Acquisition cost = Increase in marketing expense/additional subscribers
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Netflix Investor Relations: We have contacted investor relations several times, but they have failed to contact us. Here are the questions we have submitted to them. If we receive answers, we will issue an addendum to the report. 1) How will the current economic crisis affect Netflix subscribers? Do you anticipate increased churn or sluggish growth in new subscribers as a result?
2) Is Netflix looking to pursue other distribution venues such as PS3, cable, Wii via streaming content? What deals or agreements does Netflix anticipate entering into?
3) Can you comment on the developments made on your streaming video service? Does Netflix have any plans to enter into the video-game rental segment?
4) Who do you view as your “true” competitors?
5) What new projects or initiatives is Netflix undertaking to add value to the customer experience?
6) Do you expect subscriber acquisition costs to substantially increase given the increasingly competitive environment Netflix operates in?
7) Fulfillment expenses represent a significant % of Revenues (close to 10-12 % annually). Do you expect these %’s to substantially increase due to postal rate increases? What other factors might impact fulfillment expenses?
8) Innovation and technology seem to drive Netflix and keep them ahead o f the curve… Do you expect Netflix to continue to invest in R&D at current levels (4-5%) or lay off?
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Financial Ratios Profitability: Operating Margin Gross Margin Profit Margin ROA ROE
2005
2006
2007
2008
0.38% 31.73% 6.14% 11.49% 18.51%
6.54% 37.09% 4.90% 7.72% 11.81%
7.61% 34.78% 5.53% 9.75% 15.50%
8.90% 33.30% 6.08% 13.44% 23.92%
Profitability Comparison: 2008 NFLX
BBI MRFY
MVGR MRFY
8.90%
0.71%
-23.00%
Gross Margin Profit Margin
33.30% 6.08%
51.69% -1.33%
53.35% -24.90%
ROA ROE
13.44% 23.92%
-2.70% -11.26%
-92.06% 71.34%
Operating Margin
Netflix’s profitability has been trending upwards for the past few years. Their profit margin has
grown by around 50 basis points each year in the past 3 years. Their rest of their numbers increased from 2007-2008 except gross margin, which dropped about 150 basis points. However, we feel that drop is insignificant
Liquidity 2005
2006
2007
2008
Current Ratio
1.77
2.21
2.07
1.67
Quick Ratio
1.77
2.21
1.99
1.59
Liquidity Comparison 2008 NFLX
BBI MRFY
MVGR MRFY
Current Ratio
1.67
1.02
0.26
Quick Ratio
1.59
0.76
0.12
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The current and quick ratios have decreased in response to a share buyback program by Netflix and investments in their content library. Consequently, resources have been shifted to help fund future revenue growth in lieu of liquidity, but Netflix’s liquidity is adequate to meet any obligations that should arise.
Asset Management: 2005
2006
2007
2008
Total Asset Turnover
1.87
1.57
1.76
2.21
Fixed Asset Turnover
16.96
17.96
10.65
10.92
Asset Management Comparison: Total Asset Turnover Fixed Asset Turnover Days Sales in Inventory Average Collection Period
2008 NFLX 2.21 10.92 -
BBI MRFY 2.03 11.97 46.88 7.45
MVGR MRFY 3.70 22.97 47.83 -
Asset Management is doing fairly well. Their Fixed Asset Turnover fell off in 2007 but we believe that is because they spent more money on distribution centers. The TATO has increased steadily over the years, signaling efficient use of assets.
Debt Management: 2005
2006
2007
2008
0.61
0.53
0.59
0.78
Times Interest Earned
N/A
53.90
77.25
49.43
Equity Multiplier
1.61
1.53
1.59
1.78
D/E Ratio
Debt Management Comparison: 2008 NFLX
BBI MRFY
MVGR MRFY
D/E Ratio
0.78
3.17
(1.77)
Times Interest Earned
49.43
0.44
(3.81)
1.78
4.17
(0.77)
Equity Multiplier
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D/E has increased slightly over the past few years, to help finance additional growth. Netflix’s
debt load is considerably less than that of BBI and MVGR, both of which are struggling under massive debt loads. Netflix’s TIE ratio demonstrates that they generate am ple amounts of revenue to cover their debt obligations. This compares quite favorably to both BBI and MVGR, which are struggling to make payments to their creditors and could spell bankruptcy for both.
Extended Dupont Analysis: 2005
2006
2007
2008
Profit Margin
6.14%
4.90%
5.53%
6.08%
TATO
1.87
1.57
1.76
2.21
1.61
1.53
1.59
1.78
18.51%
11.81%
15.50%
23.92%
Equity Multiplier ROE
Extended Dupont Comparison: 2008 NFLX
BBI MRFY
MVGR MRFY
Profit Margin
6.08%
-1.33%
-24.90%
TATO
2.21
2.03
3.70
1.78
4.17
-0.77
23.92%
-11.26%
-71.03%
Equity Multiplier ROE
From 2006 on ROE has grown at a steady rate partly due to increasing profit margins. This shows that ROE is increasing in part because of profit and not just because of more use of debt as some companies will do to finance their expansions.
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Pro Forma Income Statement Netflix, Inc. Pro Forma Income Statement (in 000s, except eps) Revenues Cost of Revenues Gross Profit Operating Expenses Technology and Development General and Administrative Gain on Disposal of DVDs Gain on legal settlement Total Operating Expense Operating Income (EBIT) Other Income (net) Income before Taxes Provision for Taxes Net Income EPS Basic Diluted Shares Outstanding Basic Diluted
FY2005A FY2006A $ 682,213 $ 996,660 465,775 626,985 $ 216,438 $ 369,675
FY2007A $ 1,205,340 786,168 $ 419,172
35,639 47,831 180,164 261,423 (1,987) (4,797) 213,816 304,457 $ 2,622 $ 65,218 $ 5,346 14,694 $ 7,968 $ 79,912 $ (33,921) 31,073 $ 41,889 $ 48,839 $ $ $
0.78 $ 0.64 $ 53,528 65,518
0.78 0.71 62,577 69,075
$ $
FY2008A $ 1,364,661 910,234 $ 454,427
FY2009E $ 1,569,360 1,020,084 $ 549,276
FY2010E $ 1,804,764 1,155,049 $ 649,715
FY2011E $ 2,075,479 1,307,552 $ 767,927
FY2012E $ 2,334,914 1,447,646 $ 887,267
FY2013E $ 2,626,778 1,602,334 $ 1,024,443
70,979 270,616 (7,196) (7,000) 327,399 91,773 $ 19,152 110,925 $ 44,317 66,608 $
89,873 249,375 (6,327) 332,921 121,506 $ 9,994 131,500 $ 48,474 83,026 $
116,835 260,000 (6,500) 370,335 178,941 $ 12,281 191,222 $ 70,752 120,470 $
151,885 260,000 (6,500) 405,385 244,330 $ 14,423 258,753 $ 95,739 163,014 $
197,451 260,000 (6,500) 450,951 316,976 $ 16,887 333,863 $ 123,529 210,334 $
256,686 260,000 (6,500) 510,186 377,081 $ 19,248 396,329 $ 146,642 249,687 $
0.99 0.97
1.36 1.32
1.98 1.92
2.67 2.59
3.45 3.35
4.10 3.97
67,076 68,902
$ $
60,961 62,836
$ $
60,961 62,836
$ $
60,961 62,836
$ $
60,961 62,836
$ $
60,961 62,836
Revenues For Growth in revenues we used a 15 % annual growth rate. We feel that this is an appropriate rate they expand ways to reach customers and the typical brick and mortar stores are failing. In our estimates for 2012 and 2013 we use a 12.5% annual growth rate. Cost of Revenues was on average 65% of revenues in years past so we used that rate in 2009 and dropped it 1% per year into perpetuity. We did this because they said as they increase subscribers the cost of revenues will drop due to economies of scale. Operating Expenses For Technology and Development we increased the previous year by 30%. To get this number we took the average and took into account that they probably had a large investment to develop the technology to stream over the internet so lowered it a little bit For General and Administrative Expenses we kept it constant at 260,000 due to these expenses being around that number regardless of revenue growth. Gain on Disposal of DVDS was kept in line with the previous year due to us not knowing exactly how many DVDs are in their collection, and which of those they actually own. Interest Expense We set Income Expense at 2000 which is more than the 3 yr average. We grew Interest and other income at .91% because that is what it was a percent of revenue in 2008.
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$ $
333,692 260,000 (6,500) 587,192 437,251 21,904 459,155 169,887 289,268 4.75 4.60 60,961 62,836
13 | P a g e Tax Rate Tax Rate was at 37% in 2008 and we felt that this was appropriate to continue with because it dropped 2% from 2007-2008 and we felt that they would keep it low. Shares Outstanding We kept the Shares Outstanding constant from the year 2008 on. We believe that we could not accurately estimate a figure because they authorized a share buyback of 175 million in 2009.
Relative Valuations: P/E Valuation8
Projected P/E
Trailing P/E: 27.28 5 year P/E: 33.7
27.28
2009 Pro Forma Projected EPS 1.91
Resulting P/E Valuation 52.10
P/E ratios are often the best indicators of the value of a stock. In looking at the valuation from several vantage points, we decided to use a more conservative estimate and assumed that Netflix would continue to trade at the same P/E multiple, despite Netflix’s status as a high profile, growth stock. Investors are often willing to pay higher price per dollar of earnings if a stock is perceived as high growth
P/S Valuation9
Projected P/S
Trailing P/S: 1.8 5 year P/S: 1.8
1.8
2009 Projected Sales/Share 24.63
Resulting P/S Valuation 44.33
Revenues are subject to less manipulation than earnings figures are. Consequently, we thought it might be appropriate to provide a different perspective and use a P/S valuation for Netflix. To be consistent with our P/E valuation, we also assumed that the P/S ratio would continue to trade at the same levels throughout 2009. The average P/S ratio has remained relatively constant for the past five years so we thought that this would be an appropriate proxy for our projected P/S.
8 9
www.reuters.com www.reuters.com 13 | P a g e
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DCF Valuation: Sales EBIT Tax Rate Depreciation Fixed Capital Investments
2006 2007 2008 2009E 2010E 2011E 2012E 2013E $996,660 $1,205,340 $1,364,661 $1,569,360 $1,804,764 $2,075,479 $2,334,914 $2,626,778 $65,218 $91,773 $121,506 $178,941 $244,330 $316,976 $377,081 $437,251 39% 39% 39% 37% 37% 37% 37% 37% $16,648 $22,219 $32,454 $30,822 $35,445 $40,762 $45,857 $51,589 $27,333 $44,256 $43,790 $50,340 $57,891 $66,574 $74,896 $84,258
Working Capital Investments
-$59,307
$4,658
$10,112
$12,992
$14,941
$17,182
$16,466
$18,524
FCFF
$88,405
$29,287
$52,671
$80,223
$116,541
$156,701
$192,056
$224,275
FCFF=EBIT(1 - Tax Rate) + Dep - FC INV - WC INV Terminal Value in 201310 VL = (FCFF0*(1+gL))/(WACC-g L) VL = ($224,275.08*(1+.04))/(.12-.04) VL = $2,915,576.07 WACC=12% Long Term Growth=4%
Target Price
WACC=12%
PV of FCFF 2009-2013
$525,384.73
PV of TV
$2,915,576.07
PV of FCFF
$3,440,960.79
Plus Cash and Cash Equivalents
$139,881.00
Less Long Term Debt
$37,988.00
PV of Equity
$3,542,853.79
Target Price
$54.58
10
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DCF Assumptions:
Growth Rate: - 15% through 2011, 12.5% through 2013. Please refer to the Pro-Forma section of the report for details regarding why these growth rates were selected. As for the growth rate after year 2012, 4% was selected. This was done to mirror the low end of average GDP growth.
Tax Rate: -37%. Please refer to the Pro-Forma for an explanation of why this is chosen.
Depreciation: -This is value is assumed to be 1.96% of sales. This is the average depreciation percentage of sales over the last three years.
Fixed Capital Investments: -This has not varied too significantly in relation to sales the past three years. Therefore the average percentage of sales (3.21%) over the past three years was used to determine fixed capital investment.
Working Capital Investment: -Change in working capital investment was a very large negative number in 2006, but has leveled off since then. We decided to use calculate working capital as 6.35% of the change in sales from year to year. This is the same percentage that occurred in 2008. The 2007 percentage was only 2.23% but because we feel fairly uncertain as to what exactly will happen with working capital, we chose to go the more conservative path.
Weighted Average Cost of Capital (WACC): -Netflix is an interesting company in that virtually of their long term debt is in leases and not traditional debt. Because the lease terms were not revealed in Netflix’s 10K or any other documents we could locate, we could not calculate a cost of debt figure for Netflix. Therefore we consulted Bloomberg to obtain the WACC number of 12%.
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Final Points:
Competitors are failing while Netflix is thriving o
Scalable business model o
As seen by Netflix’s excellent churn rat io, once people start subscribing to Netflix, they tend to stay with it.
Poised for the future with online video streaming service o
As Netflix’s revenue increases, their cost of goods sold should not increase as much as revenues. Their large network of mailing centers and implementing automation measures makes their business model very scalable.
History of retaining subscribers o
Movie Gallery has declared bankruptcy, and Blockbuster is not even turning a profit anymore. Netflix is the only publically traded company in the movie rental doing well.
While not expected to really take off for several years, Netflix is already preparing for the future by implementing their online video delivery service now.
Implemented share buyback program o
Share repurchase program up to $175 million was recently approved by the Netflix board.11 This is a strong indicator for the health of the company.
Recommendation: Buy 1,000 shares of NFLX
11
Netflix 4th Quarter Earnings Report 2008 16 | P a g e
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Appendix 1: Blockbuster Total Access Pricing Schedule: Blockbuster Total Access Premium 3 DVDs at a time Unlimited Mail/Store 34.99 + tax
2 DVDs at a time 1 DVD at a time Unlimited Mail/Store Unlimited Mail/Store 29.99 + tax 21.99 + tax Blockbuster Total Access
3 DVDs at a time Unlimited Mail 5 free in store per month 19.99 + tax
2 DVDs at a time Unlimited Mail 3 free in store per month 16.99 + tax
1 DVD at a time Unlimited Mail 2 free in store per month 11.99 + tax
1 DVD at a time 2 per month 2 free in store per month 9.99 + tax
Blockbuster by Mail 3 DVDs at a time Unlimited Mail 1.99 in store 15.99 + tax
2 DVDs at a time Unlimited Mail 1.99 in store 13.99 + tax
1 DVD at a time Unlimited Mail 1.99 in store 8.99 + tax
1 DVD at a time 2 per month 1.99 in store 3.99 + tax
Devices compatible with Netflix:
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23 | P a g e Original Discounted Cash Flow Valuation Correction (15% Sales Growth through 2011, 12.5% for 20122013) 2006
2007
2008
2009E
2010E
2011E
2012E
2013E
Sales
$996,6 60.00
$1,205,3 40.00
$1,364,6 61.00
$1,569,3 60.15
$1,804,7 64.17
$2,075,4 78.80
$2,334,9 13.65
$2,626,7 77.85
EBIT
$65,21 8.00
$91,773. 00
$121,50 6.00
$178,94 1.15
$244,32 9.73
$316,97 6.17
$377,08 0.91
$437,25 1.21
39%
39%
39%
37%
37%
37%
37%
37%
Depreciation
$16,64 8.00
$22,219. 00
$32,454. 00
$30,821. 88
$35,445. 16
$40,761. 94
$45,857. 18
$51,589. 33
Fixed Capital Investments
$27,33 3.00
$44,256. 00
$43,790. 00
$50,339. 72
$57,890. 68
$66,574. 28
$74,896. 06
$84,258. 07
Working Capital Investments
$59,30 7.00
$4,658.0 0
$10,112. 00
$12,992. 12
$14,940. 94
$17,182. 08
$16,466. 16
$18,524. 43
FCFF
$88,40 4.98
$29,286. 53
$52,670. 66
$80,222. 96
$116,54 1.28
$156,70 0.57
$192,05 5.93
$224,27 5.08
Tax Rate
Terminal Value in 2013
$2,915,576.07
PV of Terminal Value
$1,654,376.16
Long Term Growth WACC
Target Price PV of FCFF 2009-2013
$525,384.73
PV of TV
$1,654,376.16
PV of FCFF
$2,179,760.89
4.00% 12.00% Plus Cash and Cash Equivalents Less Long Term Debt PV of Equity Shares Outstanding Target Price
$139,881.00 $37,988.00 $2,281,653.89 64912.915 $35.15
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24 | P a g e Discounted Cash Flow Valuation with 19% Sales Growth (ValueLine Rate) through 2011, 16.5% for 2012-2013 2006
2007
2008
2009E
2010E
2011E
2012E
2013E
Sales
$996,6 60.00
$1,205,3 40.00
$1,364,6 61.00
$1,623,9 46.59
$1,932,4 96.44
$2,299,6 70.77
$2,679,1 16.44
$3,121,1 70.66
EBIT
$65,21 8.00
$91,773. 00
$121,50 6.00
$198,04 6.41
$290,31 3.35
$399,92 7.20
$507,87 7.97
$630,06 4.40
39%
39%
39%
37%
37%
37%
37%
37%
Depreciation
$16,64 8.00
$22,219. 00
$32,454. 00
$31,893. 95
$37,953. 79
$45,165. 02
$52,617. 24
$61,299. 09
Fixed Capital Investments
$27,33 3.00
$44,256. 00
$43,790. 00
$52,090. 67
$61,987. 89
$73,765. 59
$85,936. 91
$100,11 6.51
Working Capital Investments
$59,30 7.00
$4,658.0 0
$10,112. 00
$16,456. 69
$19,583. 46
$23,304. 31
$24,083. 17
$28,056. 89
FCFF
$88,40 4.98
$29,286. 53
$52,670. 66
$88,115. 83
$139,27 9.85
$200,04 9.25
$262,56 0.28
$330,06 6.26
Tax Rate
Terminal Value in 2013
$4,290,861.39
Target Price
PV of Terminal Value
$2,434,749.98
PV of FCFF 2009-2013
Long Term Growth WACC
4.00% 12.00%
$686,249.26
PV of TV
$2,434,749.98
PV of FCFF
$3,120,999.25
Plus Cash and Cash Equivalents
$139,881.00
Less Long Term Debt
$37,988.00
PV of Equity
$3,222,892.25
Shares Outstanding
64912.915
Target Price
$49.65
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25 | P a g e DCF Tables 15% Sales Growth through 2011, 12.5% for 2012-2013 WACC
Long Term Growth
13.00%
12.00%
11.00%
10.00%
9.00%
4.00%
$31.10
$35.15
$40.37
$47.34
$57.13
5.00%
$34.04
$39.07
$45.79
$55.21
$69.37
6.00%
$37.83
$44.30
$53.37
$67.01
$89.76
19% Sales Growth (ValueLine Rate) through 2011, 16.5% for 2012-2013 WACC
Long Term Growth
13.00%
12.00%
11.00%
10.00%
9.00%
4.00%
$43.72
$49.65
$57.30
$67.54
$81.91
5.00%
$48.05
$55.42
$65.28
$79.11
$99.92
6.00%
$53.62
$63.11
$76.44
$96.48
$129.94
Each table shows the resulting target stock price for the respective WACC and long-term growth rate. For example, in the first table a WACC of 11% and a long-term growth rate of 5% equals a $45.79 target price. Conclusion While our original very conservative DCF valuation no longer provides a satisfactory target price, this should not be cause to immediately dismiss Netflix. The ValueLine growth rate DCF is a very plausible scenario given Netflix’s new streaming initiative , their scalable business model, and opportunity to cannibalize on the market of the other failing rental companies. Furthermore, the table of target prices based on different WACCs and long term growth rates shows this valuation’s extreme sensitivity to numbers that are very difficult to estimate.
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