Just a little over a year back, investor mood was all doom and gloom when it came to the stock of Netflix. By April 2022, the stock had corrected by 73 per cent from its all-time high of $700 to $190. This entire correction had happened in a matter of a few months. Further, the exit by famed investor Bill Ackman booking a loss of over $400 million in his Netflix investments, after buying into the stock just three months earlier, further added to panic amongst investors.
Amidst all this, in our bl.potfolio edition dated May 1, 2022, and our note titled Twist in plot makes for a gripping entry point we had recommended that it was time for investors to get their foot inside the door of Netflix and start accumulating the shares. Investor frenzy and euphoria had got crushed with the 73 per cent correction, making the risk-reward very attractive for a high-quality stock when it was trading around $190 levels. The stock valuation then was at PE of 15 times and EV/EBITDA of 12 times (both CY23 estimates).
A year from then, the stock has returned nearly 100 per cent by last week. With the stock trading at $379 and one-year forward PE of 30.5 times and EV/EBITDA of 22.3 times, we believe it’s time to book profits and lock in on the gains. The risk-reward in the stock is not favourable anymore amidst risks to the downside.
The upside in the shares in the last one year have been driven by turnaround in fundamentals as well as shift in investor sentiment. Since the disruptions in early 2022, the company has focussed on improving specific financial operating parameters over aggressively investing for growth. This has resulted in better cash flows than expected. As the company tapered its investments in content to focus more on quality than just quantity, cash flows improved substantially. As compared to CY22 free cash flow estimates of $832 million in April 2022, the company actually managed to report free cash flows of almost twice the expectation at $1.6 billion.
More importantly, from the middle of last year, the company saw stabilisation in quarterly subscriber declines. After initially guiding for net subscriber loss of two million in Q2 of 2022, it actually managed to stem the losses to below one million for the quarter. This factor, and improvement in cash flows, were the prime factors driving the shift in investor sentiment in the stock and the stock has been in an uptrend since July 2022. Further, initiatives like introduction of ad-supported lower priced subscription plans have also helped stabilise subscriber trends and long-term outlook.
However, here is the interesting thing to note – as compared to a year back versus now, besides cash flows and subscriber trends, the numbers are not significantly better off versus last year. In fact, consensus revenue and EBITDA estimates have been revised down by 6 and 11 per cent to $33.9 billion and $7.2 billion respectively for CY23, from April 2022 to now.
The stock returns have been primarily driven by expansion in valuation multiples rather than any significant increase in near-term revenue and profits. Thus, the long-term prospects of better subscriber, revenue and profit trends driven by initiatives like ad-supported subscription plans and more efficient investments, appear to be adequately factored at current levels, making the risk-reward unfavourable. This apart, competition remains strong in the streaming space from well-established players like Disney, Hulu, Paramount and HBO.
Disney is a better bet
In our view, a better way to play the global opportunity in media and entertainment is via the Walt Disney Co (Disney). In our bl.portfolio edition dated July 10, 2022, we had recommended that investors accumulate the stock of Disney. A leading global media and entertainment conglomerate with a 100-year history of successful execution, Disney remains an attractive investment opportunity for long-term investors. Since our original recommendation last year when the stock was trading at $96, it is down by 8 per cent. At current price of $88.29, the stock is valued at a one-year forward PE of 18.3 times and EV/EBITDA of 11.9 times, cheaper by about 5 per cent now versus July 2022. We recommend a buy on the stock now.
Long-term prospects remain quite good. With diversified revenue streams – 25 per cent from streaming business (similar to Netflix business), 40 per cent from linear networks and content licensing and the rest from Theme Parks and consumer products business, Disney is one of the best diversified entertainment players. The company also has leadership or significant position in most of the segments it operates in. For example, in streaming business across its multiple offerings – Disney+, Hotstar and Hulu (67 per cent owned by Disney), its total streaming subscribers globally of 228 million are comparable with Netflix’s 235 million subscribers. Although Disney’s average revenue per customer is lower, it was a late entrant compared to Netflix in the streaming business and is in the process of monetising its content better, which will reflect over the next few years.
All of Disney’s business segments, excluding streaming, are profitable and its overall profitability has been tempered, driven by investments in streaming. Thus the operating leverage in Disney’s streaming business is yet to play out and does not appear to be reflected in its current valuations.
In November 2022, the company also saw a significant management change with oldtimer Bob Iger returning as CEO, ousting Bob Chapak. This was a surprise move as Iger had handed over the reins to Chapek only in 2022. Chapek’s ouster followed some controversial strategic decisions that did not go down well with the board and employees. Investors reacted positively to this news, given Bob Iger’s solid track and the change augurs well.