Netflix Q4 results were not a horror story

Stress testing the valuation drivers

Analysts have questioned the sustainability of subscriber growth and the viability of margin growth as streaming competition intensifies, the US market matures, and content costs increase. We consider these key valuation drivers thoroughly in our investment process and routine scenario analyses, and, as seen below, the stock remains attractive over the long-term.

Our bear case scenario incorporates the following assumptions:

• Around 40% penetration of the addressable 800 million PayTV/broadband households globally excluding China;

• Pricing growth of 1.94%, compared to FY17-FY21 pricing CAGR 7.21%;

While subscriber growth is a key element of revenue growth, we believe the market underestimates Netflix’s pricing power.

Global pay TV revenue peaked at $201 billion in 2016, and many analysts draw parallels between that figure and the total addressable market value for streaming revenue. We consider the comparison to be flawed, because the pay TV figure represents a limited segment of TV households in largely developed markets and featured an inferior user experience. It also underestimates consumers’ willingness to pay, as scarcity of resources and value for money drive pricing power.

As competition intensifies, leading content creators will likely gravitate towards the most efficient content distributors to reach the largest audience base. Netflix’s scale and data-driven investment approach to content enables it to maximise value to subscribers, thereby enhancing its pricing power.

Engagement

Analysts have increasingly pointed to competition as a limiting factor to Netflix’s pricing power. However, Netflix’s intention to raise prices in the US indicates otherwise. It tends to raise prices strategically when it believes it is delivering a strong value proposition as reflected by key engagement metrics. As noted by management during the Q4 call, “Retention was strong. Churn was down. Viewing was up.” during the quarter. Netflix has a proven track record in its value-driven positioning and pricing approach where it raises prices in mature markets to drive cash flow and offers cheaper plans in newer markets that are scaling.

Focus on the long term

This exposes another concern emphasised by analysts, which is slowing subscriber growth in under-penetrated markets such as Latin America and Asia Pacific. To this point, we believe Netflix’s content strategy will play out in the long run. On an industry level, those markets still have a strong growth runway in terms of broadband penetration, which is still only around 60%.

Netflix has consistently demonstrated its ability to produce quality local content that scales globally (Squid Game), and global programming that competes with theatrical releases for audience and attention (Red Notice).  

Netflix’s moat will continue to expand and strengthen with an ever-expanding ecosystem of content, creators and subscribers. We believe the company’s proven track record and focus on providing customer value will generate long-term shareholder returns.