Netflix (NFLX) - Get Report shares are down on near-term concerns based on its earnings report. However, the long-term risks haven’t necessarily changed, and Wednesday’s dip could be a good time to buy for those that are indeed bullish on the company.
The stock fell as much as 5% Wednesday to about $500 a share and was trading at about 40 times enterprise value-to-EBITDA (earnings-before-interest-tax and non-cash expenses) on a forward basis leading into earnings. Most analysts use a multiple in the 30’s for Netflix. The stock had a lot to lose.
Here were the results against analysts’ expectations:
- Revenue: $6.44B v. $6.39B (actual: +22% year-over-year)
- Net Paid Subscriber Adds: 2.2M v. 3.4M (-67%)
- Operating Margin: 20% v. 18% (+2 percentage points)
- Earnings Per Share: $1.74 v. $2.13 (+18%)
- Free Cash Flow: $1.15B v. $200M
Management said a $249 million non-cash charge related to debt expense was responsible for the earnings miss. Indeed, adding that back would have brought Netflix to an earnings beat. Of course, it is subscriber growth that investors care most about, and management guided for 6 million net new subscribers in the current quarter, versus estimates of 6.5 million expected by analysts, pointing to continued pressure. Positively, Netflix is proving that it can ratchet down its marketing spend relative to revenue, as it benefits from increased scale, a dynamic reflected in the continued improvement in the operating margin and free cash flow. Management said free cash flow could be slightly negative to break-even in 2021 as production ramps back up, but the long-term trajectory is still positive.
The earnings and guidance confirmed the massive pull-forward of streaming adoption that investors had been wary of. The following, highly forward-looking comment from management is one of the most pressing factors bringing the stock down: "we expect paid net adds are likely to be down year over year in the first half of 2021 as compared to the big spike in paid net adds we experienced in the first half of 2020.”
However, the next comment management made on the earnings print: "We continue to view quarter-to-quarter fluctuations in paid net adds as not that meaningful in the context of the long run adoption of internet entertainment, which we believe is still early and should provide us with many years of strong future growth.”
Essentially, investors are nervous about near-term earnings power given the demand pull-forward, but nothing has fundamentally changed the long-term growth story. While 2021 will pose a difficult comparable to 2020, 35 million added subscriber for 2021, according to FactSet consensus estimates still equates to roughly 20% revenue growth.
"The company guided to net addition growth in 1H21 being lower than this year, but given the tough comp vs 1H20, this was already expected (Barclays estimate: 9.8mm, lower than 1H’19 vs 1H’20 at 26m),” wrote Barclays analyst Kannan Venkateshwar in a note.
“We are not claiming Netflix has reached global maturity and we still expect strong subscriber, revenue and earnings growth longer term,” wrote Moffet Nathanson analyst Michael Nathanson in a note.
Long-term top-line growth is still on track and analysts model a 30% long-term operating margin, according to FactSet. That points to continued explosive earnings growth. And for free cash flow in 2021, Nathanson is looking for negative $600 million. Venkateshwar said marketing spend is not expected to increase much in 2021, making management’s operating margin guidance conservative. Barclays even says that, because Netflix could generate $10 billion in free cash flow by 2025, "the scale of buybacks could be significant.” Buybacks are not modeled into the stock at this point.
RBC Capital Markets analyst Mark Mahaney, citing a free cash flow "inflection point” coming soon, raised his price target to $630 from $610.
Plus, with analysts not moving their near-term earnings estimates too much, the valuation is now closer to 35 times 2021 EBITDA. For investors looking to buy the dip on a company whose valuation is difficult to model, Wednesday might just be an opportunity.