Please ensure Javascript is enabled for purposes of website accessibility

Can Netflix Live Up to Its Lofty Valuation?

By Travis Hoium - Oct 21, 2015 at 5:00PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

How many subscribers does Netflix need to live up to the market's expectations?

Image source: Netflix.

Netflix (NFLX 2.90%) is worth $42 billion as I'm writing, something I'm having a hard time getting my head around. How can a company that is a middleman in content distribution worth nearly as much as content owners like Time Warner (TWX) and Twenty-First Century Fox (FOX), who have much more revenue, more profit, and well established businesses?

NFLX Revenue (TTM) Chart

NFLX Revenue (TTM) data by YCharts.

The reason Netflix is worth so much is that investors have assumed it will be a growth machine for years to come, disrupting businesses like Time Warner and Fox. But to give investors an idea of how far Netflix has to go, let's work backward from the profit levels I think Neflix will eventually have to reach. 

Living up to Netflix valuation
To provide a baseline, I think we should be able to see a way Netflix can reach the valuation metrics of its big competitors. As an example, both Time Warner and Fox trade for 13 times next year's earnings estimates. Since they're both content companies with streaming arms and mature businesses, they're probably a good proxy for where Netflix will have to get someday. 

Netflix's current market cap of $42 billion, then, means that eventually, it will have to make $3.2 billion in annual profit to trade at a comparable forward earnings multiple.

To back into revenue required to reach that figure, we have to make some assumptions about future net margins. If we assume an annualized contribution profit for international operations of 30% (similar to domestic margins), constant "other operating expenses" and "other income (expense)," and a tax rate of 30%, we get a net margin of 10.7%. That means to have $3.2 billion in net income, Netflix would have to generate $30.0 billion in revenue. 

Seems easy enough given projected 2015 revenue of $6.1 billion and a current growth rate of nearly 30%, but Netflix may need more than new subscribers to reach the market's lofty expectations. 

Image source: Netflix.

How many subscribers does Netflix need?
In the U.S., Netflix's average subscriber paid $8.21 per month last quarter. That's due to rise $1 per month over the next year, and a standard plan will be $9.99 per month. With that increase already in the works, let's assume an average subscription fee of a round $10 per month per subscriber. Or $120 per subscriber, per year. 

That means Netflix would have to attract 250 million subscribers to live up to its market value, assuming it keeps subscription prices at $10 per month and meets the margin targets I outlined above. To put that into perspective, almost 1 in every 5 households in the world would have to subscribe to Netflix. 

Food for thought
None of this analysis is to suggest that Netflix stock isn't going to go up, or that the company won't adapt and change in the future. I'm simply trying to put the company's current market value into context versus competitors given Netflix's current business model. 

To live up to the market's valuation, the company will likely have to push through a lot more price increases and still grow its subscriber base at a rapid rate, all while holding off competition from content studios. Can it do all of that? That's something to think about. 

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Netflix, Inc. Stock Quote
Netflix, Inc.
NFLX
$179.95 (2.90%) $5.08
Twenty-First Century Fox, Inc. Stock Quote
Twenty-First Century Fox, Inc.
FOX
Time Warner Inc. Stock Quote
Time Warner Inc.
TWX

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
311%
 
S&P 500 Returns
110%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/01/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.