Scheduled (linear) TV programming has been
properly disrupted by the emergence of internet entertainment services. Why
wait a week for the next episode of your favourite series or documentary when
you can binge watch at times more convenient to you? Also, why do you need those
decoding boxes and satellite dishes when you can achieve a similar result with
an internet connection and an app?
With the evolution of technology, on-demand
internet entertainment seems destined to eventually end the era of scheduled
linear television. The increase in availability and speeds of the internet,
combined with a higher penetration of smartphones and smart televisions,
provides an ever-growing ecosystem with greater access to the world of
entertainment. Netflix has emerged as a leading provider within this
entertainment service category, boasting over 130 million memberships across
more than 190 countries.
Netflix
Origin(al)
From humble beginnings as a
DVD-rental-by-mail firm in 1997, Netflix moved on to list on the Nasdaq in 2002
at $15 a share, only becoming profitable in the 2003 financial year, when it
was still primarily a DVD shipping company. The introduction of streaming
entertainment came in 2007, from which point revenue growth started its
exponential path. The company now trades at around $370 a share, roughly 25
times its initial offering price.
Their second quarter (Q2) results for 2018
once again showed strong revenue and earnings growth for the group. Revenue
increased by just over 40% year-on-year, while better operating margins equated
to a more than 260% increase in operating income. Earnings per share moved from
15c* in Q2 2017 to 85c in Q2 2018.
The financials were realised more or less
within previously (Q1 2018) guided estimates from the company.
However, the initial market reaction to the
company’s results was negative, with a low double-digit share price decline
being realised intraday. The move was on the back of lower-than-expected
membership growth, although it must be said that the number of members added to
the subscription base was still large at 5.2m. Of these 5.2m net additions, 670
000 were in the US (estimate 1.2m) and 4.5m were international (estimate 5.2
m).
Put into context, Netflix has seen a net
addition of between 5m and 8m members every quarter since Q4 2016, exceeding
its guided subscriber estimates all but two times (where misses have been
marginal) over the last seven reporting quarters.
Forecast
for the third quarter
The next quarter is expected to yield
revenue growth of around 34% year-on-year and realise earnings per share (EPS)
of 68c per share, up from 29c in the comparative quarter (2017). EPS will be
lower than Q2 2018 on account of more costs of content production being
realised in the second half of the financial year.
Fundamentals
At face value the fundamentals may not
conform to the usual investment criteria for a long-term portfolio holding, but
contextualised perhaps they do.
The company trades on a price-to-earnings
(P/E) ratio of around 160 times, which is expensive. However, it is now less
than half the P/E premium of December 2016 (when it was at 346 times). The
earnings growth is expected to see the P/E reduced to less than 60 by 2020.
Netflix does not yet pay a dividend, and
free cash flow is negative, at -$559m. It should be considered, however, that
the company is making significant investments in content production, which is
expected to produce high returns and further shareholder value in the long run.
The quality of the content produced has
seen Netflix receiving the most Emmy nominations (112) in 2018, breaking the
previously uninterrupted honour held by HBO. It must be remembered that Netflix
created its first original content only five years ago. The content looks to
secure and maintain viewers within the company’s ecosystem and is now being
produced in 80 countries.
The
investment case
While businesses like YouTube, Disney,
Amazon and Apple (to name but a few) are all investing within the internet
entertainment services space, Netflix has had the first move advantage in the
subscription-based online video streaming industry.
The future scope of the industry remains
enormous, with enough room for competitors to co-exist profitably. Consumer
demand remains high with increased accessibility, better data mobility and connectivity
further helping to feed the appetite for on-demand online entertainment.
Investors looking for a growth stock and
tech sector/e-commerce addition to a long-term portfolio might find Netflix a
worthy consideration.
*All cent values denote US currency.
Shaun
Murison is a market analyst at IG.
This article originally appeared in the 2 August edition of finweek. Buy and download the
magazine here or subscribe to our newsletter here.