Netflix (NASDAQ:NFLX) was one of the biggest beneficiaries of stay-at-home measures put into place earlier this year, at the onset of the coronavirus pandemic. Its stock is up 48% so far in 2020, compared to the paltry 4% gain for the S&P 500 index.
This was on the heels of a truly extraordinary decade for the streaming entertainment innovator. Revenue grew at a compound annual growth rate (CAGR) of 28.3% from 2009 to 2019, and the company currently has 195 million subscribers using its service.
With a market capitalization of $216 billion that already exceeds mega-cap status, how much higher can the stock go?
Netflix's annual membership growth has accelerated over the years, and the company is slated to gain 30 million new subscribers in 2020. Over the long term, let's say by 2030, Netflix could easily reach close to 500 million subscribers if it adds 30 million per year over the next 10 years. While this seems like an astronomical figure, I think it is quite conservative.
According to a report published last year by the World Advertising Research Center (WARC), nearly three quarters of internet users across the world will access the internet using just their smartphones by 2025. By 2030, there will be an estimated 5.2 billion smartphone users in the world, excluding China (Netflix is not offered there). At 500 million subscribers, Netflix would have 9.6% of this group as its customers. For comparison's sake, the company has a 23.8% penetration of smartphone users in its most mature markets, the U.S. and Canada.
Netflix average revenue per user (ARPU) per month increased from $7.81 in 2016 to $10.82 in 2019, representing a CAGR of 11.5%. Pricing is different in various countries, and multiple tiers are offered depending on the number of streams happening simultaneously, both of which affect these figures.
If the company modestly raises ARPU by 4% per year through 2030, Netflix could hit $100 billion in annual revenue as its ARPU per month reaches $16.67. Given Netflix's propensity to periodically raise prices, this is completely feasible.
Revenue of $100 billion is more than four times trailing 12-month sales of $23.8 billion. It's hard to wrap one's head around a company this size continuing to grow at such a high clip, but Netflix's business model allows it to scale rapidly. Offering streaming entertainment has a marginal cost of nearly zero, and Netflix's service actually gets better the more users it has.
Netflix's operating margin continues expanding year over year, and is projected to be 18% for the full year 2020, up significantly from just 4% in 2016. Management believes that the long-term trajectory of margin improvement is 3% per year, a clear sign that the company will begin benefiting from considerable operating leverage as content spending levels out over a much larger user base.
By 2030, Netflix could produce earnings before interest and taxes (EBIT) of $48 billion calculated from an operating margin of 48% (a 3% increase every year from 2020 to 2030).
What does this mean for the stock price?
Based on what I think are conservative estimates laid out above, Netflix's market cap could easily exceed $1 trillion in 10 years. The stock currently trades at an enterprise value (EV) to EBIT multiple of 54.7, so applying an extremely moderate multiple of 21 times EBIT would equal a $1 trillion valuation in 2030. At this point, I think Netflix will be generating such a massive amount of cash that it will be in a net cash position, as opposed to the net debt position it's in now.
Mr. Market could cut Netflix's multiple by more than half, and the stock would still have the potential to provide a 16.7% annual return over the next decade. It's difficult for investors to fathom that a high-flying stock can keep trending higher, but Netflix has all the makings of an enduring growth story.
If you missed out on the huge gains of the past, now is your time to bet big on this streaming giant.