On Tuesday, Netflix (NFLX, Financial) reported financial results for the fourth quarter of fiscal 2020. In the period, the world's leading streaming entertainment service added 8.5 million net subscribers. For the full year, Netflix added more than 36 million net subscribers, by far the strongest year in the company's history (the prior record was the 28.6 million net subs that Netflix added in 2018).
As a result, the company now has more than 200 million subscribers around the world. As shown below, Netflix has nearly tripled its global subscriber base over the past five years (over the same period, the company's global blended ARPU has increased from ~$8 a month to ~$11 a month).
Revenues for the year increased 24% to $25.0 billion, primarily due to the 20%+ increase in paid members, as well as low-single digit growth in average revenue per user (ARPU). As noted in the shareholder letter, ARPU increased by 2% in the U.S. and Canada (UCAN) region, primarily attributable to the price increases implemented in October 2020. In the Europe, Middle East and Africa (EMEA) and Asia-Pacific (APAC) regions, ARPU was unchanged from 2019 (FX neutral), with ARPU climbing 4% in Latin America.
Unsurprisingly, the results in 2020 were materially impacted by the pandemic. As shown below, Netflix experienced a significant acceleration in subscriber adds beginning in March and April, around the time when work from home and shelter in place orders became commonplace.
Impressively, even as pandemic-related restrictions eased in the back half of 2020, Netflix did a good job of retaining many of the customers that it had acquired over the previous six months. This suggests that the company continues to do a good job convincing its incremental customer that the service is worth paying for. The combination of sub growth and higher ARPU's, along with one-time benefits related to the pandemic, enabled Netflix to report meaningful growth in 2020, with operating income climbing 76% to $4.6 billion. For the year, Netflix reported operating margins of 18%, up 500 basis points from 2019 and in-line with guidance. In 2021, management expects another year of improvement, with margins predicted to climb another 200 basis points to 20%. As shown below, the company has seen a persistent improvement in its margins in each of the past five years.
As the business continues to achieve global scale, I expect margin expansion to continue. The company stated in the earnigns results that "we intend to continue to grow our operating margin each year at an average rate of three percentage points per year, but we anticipate some lumpiness." To the extent that doesn't materialize in the short-term, I would expect that's a desirable outcome for shareholders and customers alike. I think this will likely be as a result of bidding for licensed content from media companies that have to throw in the towel on their own DTC efforts.
As we look to the years ahead, opportunity abounds for Netflix. Video on demand has largely replaced linear television (at least for entertainment programming) for hundreds of millions of people around the world. Due to its first mover advantage and a willingness to bet aggressively on its vision, Netflix has become the default, the starting point, the place where millions inevitably begin their search for tonight's entertainment. Even as competitors like The Walt Disney Co. (DIS, Financial)'s Disney+ and HBO Max scale, I'd aruge that Netflix's leadership position is likely to be upheld.
Conclusion
Valuing Netflix comes down to three key variables: global subs, ARPU, and margins. Given the results reported in 2020, including management's optimism for the evolution of the income statement in the years ahead, I feel comfortable assuming that this business, over the long run, will have at least 400 - 450 million global subscribers, a global ARPU north of $12 - $13 a month, and 25% - 30% operating margins (and I wouldn't be surprised if each of those estimates proves too conservative). By my math, that suggests the business will generate at least $35 - $40 per share in operating income in the relatively near future. At a current price of $575 per share, the stock trades at a mid-teens normalized EBIT multiple. Given that this is an estimate of where EBIT may be in five or ten years, we should discount it appropriately. Personally, as I think about the amount of time and risk associated with this outcome, a current multiple of 10 to 15 times feels reasonable (at the midpoint, that results in a mid-single digit CAGR if this result takes 10 years to materialize).
For those reasons, I think a reasonable range for Netflix shares is around $350 - $600 per share. Said differently, if the stock trades at or below the low end of that range, I'm likely to be a buyer. (It's also worth remembering that I have a large position in Disney (DIS, Financial), which makes this decision less straightforward for me than it may for others with no exposure to the industry.)
Disclosure: Long DIS [The Walt Disney Co]
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