Content and Distribution Expanding Competitive Moat; International Front and Center-Raising Price Target to $500
We believe Netflix has a number of growth levers which should fuel the company’s next phase of strategic penetration among both US and especially international consumers with our recent survey work showing that the average Netflix user is watching the streaming service 10 hours+ per week which is nearly double its nearest competitors Amazon and Hulu which is closer to 5 hours per week, an “eye popping” disparity in our opinion. While the landscape for original content has become increasingly competitive with new entrants entering the market by the day (Disney/Comcast bidding war for Fox remains a wild card) we believe Netflix remains in a unique position of iron-like strength to grow its content and distribution tentacles over the next 12 to 18 months and thus further build out its massive content and streaming footprint. Our bullish thesis on Netflix is based on our belief that the company’s competitive moat, franchise appeal, ability to increase international streaming customers through 2020, and original content build out will translate into robust profitability and growth as the next phase of this story plays out over the coming year with $10 of earnings power by 2022. We maintain our Highly Attractive rating while raising our price target from $400 to $500 on Netflix to reflect stronger than expected subscriber growth for the rest of 2018 and 2019.
International growth showing major tailwinds. Netflix has talked about its US domestic penetration potential in the 60M to 90M range with our estimate that by 4Q they break the 60M mark and mid to high single digit domestic growth sustainable from 2019-2021. The holy grail of incremental growth (and profitability) going forward will be from international customers as we believe Netflix has a TAM of over 700M subs by 2020. With the company spending major resources over the last two years building out a global distribution arm and customer base in over 100 countries, we believe the fruits of this labor will start to be fully realized in 2018 and beyond as evidenced again by our strong 2Q checks with a few weeks left in the June quarter. With the US market starting to see a normalized growth rate after a period of hyper-growth, we believe Netflix has potential to get 100M international subs by early to mid 2020 (vs. ~68M today), thus rounding out the long-term growth and margin story for the coming years. With the international segment turning the corner on profitability and showing stronger than expected sub growth in 1Q with “very positive tea leaves” for 2Q, we believe this incremental growth will flow to the bottom-line for the rest of 2018 and beyond and translate into significant cash flow and EPS growth, a dynamic that we believe is still underappreciated by the Street today. We also believe another core growth driver around 4K Ultra HD TV represents an opportunity both internationally as well as domestically for Netflix. Our recent survey work indicated that 87% of current Netflix customers would accept further price increases to stay with the flagship streaming service, which speaks to the “price inelasticity” the company has built with 4K Ultra HD carving out another avenue to raise prices over the next 12 to 18 months in our opinion as this content/programming ramps accordingly. To this point, as international growth ramps along with profitability, we believe the Netflix growth story will transition from purely domestic driven into a global streaming play, original content behemoth, and rising ARPU franchise translating into a higher multiple and significant long term earnings power and speaking to our bull case scenario for shares of Netflix over the coming year with the Disney/Comcast battle royale representing a lingering long term competitive variable.
Netflix watching the Disney/Comcast battle royale play out. When Disney and Iger originally made the $52 billion bid for 21st Century Fox assets the view among many on the Street was that with the company’s streaming standalone service set to launch in 2019 gaining these massive content assets, sports networks/content, and ownership of the crown jewel Hulu was a major competitive threat to Netflix with Iger piloting the streaming plane. This ultimately was a lingering overhang for Netflix as essentially the company has dominated the streaming world with 125 million subs and growing rapidly, spending $8 billion this year on content (mostly original), and thus being the spark that will cause a massive consolidation wave across the media and broader TMT landscape with AT&T/Time Warner and the 21st Century Fox asset jump ball just the tip of the iceberg in our opinion. For Netflix, Disney’s ownership of Sky assets, Hulu, and all the golden 21st Century assets would make Iger & Co. a legitimate force in the streaming world for years to come and thus form a content behemoth that would rival Netflix from a content perspective with a unique web of distribution capabilities and brand awareness that is unmatched. To this point, Comcast entering the 21st Century sweepstakes last week with a robust $65 billion all cash bid has thrown a “major wrench into Iger’s plans” and ultimately that is a positive for Netflix. From Netflix’s perspective a bidding war and potentially a breakup up of some key assets to multiple bidders (Hulu front and center, Sky) to navigate any regulatory hurdles would be a major win for Hastings & Co. not to have all these assets under one hood and especially under the control of Disney. While Comcast longer term if they win this battle would have major content assets on the streaming front and likely become a significant streaming player over time (2-3 years down the road), Disney remains the most viable competitive threat to Netflix near-term especially with its standalone service set to launch in the next 9 months and 35-40% of domestic box office share/content potentially under its hood. While this battle for the 21st Century assets is set to play out over the coming weeks, Netflix will be watching the situation closely as the Disney competitive shadows on the streaming front will become a lot less onerous if Comcast and Roberts ultimately prevail in its bid.