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Dixon's Take: Netflix Still Has Room to Run


Think Netflix is flying too high? In fact, shares are still trading near the midpoint of historical media valuation levels.

A little over a year ago, I was ruminating about Netflix (NASDAQ:NFLX) and using it as a tutorial for valuation. (See: Dixon's Take: A Holiday Lesson About Netflix and Its Future.) At the time, the stock was trading in the mid $70s on its way to $129 before retracing back to the mid $50s, and I had calculated that a reasonable target of over $100 was achievable. Here we are 15 months later with the stock trading at $216, which forces the question: Is today's price justifiable? In a word, yes. Here's the logic.

Currently Netflix has approximately 30 million US subscribers plus an additional 7 million subscribers outside of North America, which puts the company on track to achieve 45 million by year-end.

Assuming an average monthly $10 ARPU (let's keep the number simple) results in $450 million of projected revenue per month, or annualized revenue of $5.4 billion by year-end, applying a traditional 25% EBITDA margin (a normalized cable television network margin) suggests normalized EBITDA of $1.350 billion or projected pro forma forward EBITDA of $22.50 per share.

Currently the company has an equity capitalization of $13 billion and net cash of $514 million, resulting in a total enterprise value of $12.5 billion (the equity value less the cash), which, when divided by estimated future EBITDA of $1.35 billion, suggests a rather ordinary 9.25 TEV/EBITDA trading multiple.

(See also: Is the Netflix Stock Boom a House of Cards?)

As most media companies trade in a range between 8 to 12 times, this is not an outlier; given the company's competitive positioning and focus, there is every reason to believe it could trade up to the higher end of the multiple range. A little math (12x 22.50 + 514/60) puts that target above $270.

Can the company achieve $1.35 billion in EBITDA?

Adding back the approximately $500 million of content amortization reported in the first quarter to the $31 million in operating income and annualizing that number actually puts the company on track to generate an annualized run rate EBITDA of over $2 billion -- so yes, Netflix has some room to run.

But what about investment in content and the deleterious impact on earnings? For the period, investment in content exceeded amortization by approximately $88 million, and it is likely that the company will continue to expand its production as its primary use of cash. But over time as the self-produced library continues to grow and the life of individual projects lengthens, margins expand, providing confidence in the company's ability to achieve the targeted 25% pro forma margin articulated earlier.

A scene from House of Cards, a Netflix Original Production.
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