Netflix

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Netflix is a global entertainment company offering a subscription-based streaming service with a vast library of TV shows, movies, documentaries, and stand-up comedy specials.

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The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Netflix’s moat is a 3/5 because it possesses a combination of brand recognition and content creation capabilities, but faces increasing competition and changing consumer preferences. The content moat is not the strongest. Let’s take a closer look.

Understanding the Business

Netflix’s business is primarily built around the streaming entertainment it provides to its subscribers.

  • Revenues Distribution: Netflix’s revenue stream is predominantly based on recurring membership fees. Revenue is broken down into 4 regions : UCAN, EMEA, LATAM, and APAC. As of 2022, UCAN had around 77M paid memberships, EMEA around 75M, LATAM around 40M, and APAC around 40M. Netflix has also recently started experimenting with other revenue models such as paid sharing and an ad-supported tier, but their revenue contribution is still small and will take some time to materialize.

  • Industry Trends: The streaming industry is witnessing explosive growth. However, the market is also becoming increasingly crowded, with new players entering the market and established players launching their own streaming services. This is intensifying competition for both subscribers and content. The rise of FAST channels, short-form videos, gaming, and the metaverse has also started to eat away the time of consumers, who used to allocate time for streaming services.

  • Margins: Netflix has shown strong margins on its core business for a long time. But now, as competition increases and the company spends more on original content, its margins have started to narrow. In order to maintain and grow its margins, Netflix is looking at new revenue streams such as ad-supported plans and paid sharing of accounts. Netflix’s operating margins have stabilized at 20%, with the plan to increase this.

  • Competitive Landscape: Competition is fierce. Established players like Disney+ and Amazon Prime Video have deep pockets and high-quality production capabilities, while newcomers like Paramount+, Apple+, and Warner Bros. Discovery+ are also gaining market share. This crowded space makes it much more expensive and difficult for Netflix to maintain, or increase market share. The competition is coming both from major studios as well as from new streaming services and user-created content. All of these combined pose a serious threat to Netflix.

  • What Makes Netflix Different: Netflix has a huge library of content (both licensed and original) on which they have had success. They also have extensive experience with how people use video streaming, and their UI/UX on multiple devices are very good and popular. Although, competitors have caught up on most of the areas, it still gives Netflix an advantage of being “the streaming” platform in customers’ minds. Their data-driven approach towards recommendations is also a valuable advantage. Lastly, their brand is extremely strong worldwide, which gives them a head start in multiple countries.

  • Recent Controversies & Problems: Netflix’s challenges recently involve declining revenue growth and a loss of subscribers in key markets, such as UCAN, due to increased competition, password sharing, and economic challenges. They have also faced criticism for producing content that is not generating adequate subscribers or views. Management believes new revenue streams, content strategy, and international expansion are their best chance for growth. One thing the company is doing to help with cost cutting is curtailing its free cash outflow (or burning money).

Financials In-Depth

Netflix’s most recent 10Q has some great data points that we can analyze:

  • Revenue: Netflix’s revenue grew to $32.8 billion for the full year 2023, a 6.7% growth from last year. Most of the growth is from price hikes, and the company is focusing on revenue growth instead of membership growth. This shows that Netflix is more of a mature company and has moved from rapid expansion.

  • Profitability: Netflix’s operating margin is 20% which has been consistent over the past few quarters. Net profit of over 5 billion dollars for 2023 is really good for any company. Although, the free cash flow is positive, the company spent 2.2 billion in cash to acquire content and 1.6 Billion on technology. This high expenditure for content will be the key driver for future performance.

  • Balance Sheet: Netflix’s balance sheet is reasonably healthy. The company has about $7 billion in cash and short-term investments and $11.2 Billion in debt. They have also been successful in limiting some of their content spending.

  • Key Metrics: Netflix had 260M subscribers worldwide. The company has 73.5 million in UCAN, 87 million in EMEA, 45 million in LATAM, and 53 million in APAC. The company has started to report on average revenue per user, which now they have said will be the key metric to watch. The average revenue per user is down YoY for UCAN and LATAM, which means pricing pressures are still there and more people are choosing ad-supported plans or other cheaper alternatives.

Overall, Netflix’s financials are reasonably good at the moment. The company’s focus on revenue growth, and improved margins, as well as positive free cash flow means that the company is taking all the right steps. The recent price increases have also had very little effect on churn, according to the management.

Legitimate Risks to the Moat and Business Resilience

The moat and the business are at risk from following things:

  • Competitive Pressures: As the market gets more crowded, the competition for content, subscribers, and prices will increase, putting pressure on margins and profits. This is the largest and most concerning issue for Netflix at the moment.
  • Content Creation Costs: Production costs are rising rapidly due to the increased demand for talent, a larger number of productions, and higher standards of consumers. This could erode their profits as well as free cash flow and might affect pricing strategy.
  • Subscription Fatigue: Consumers may reach a saturation point in the number of subscriptions they can afford or maintain. This can cause a slowdown in growth and even outright subscriber losses.
  • Technological Disruption: New technologies or consumer habits may emerge and render their current streaming model irrelevant.
  • Economic Slowdowns: In tough economic conditions, consumers usually cut down on discretionary expenses like streaming services, impacting top-line numbers.
  • Macro Events: The political climate has an adverse effect on the content produced as well as the profitability of international operations for Netflix.

The resilience of Netflix’s business is relatively good due to its global nature and brand, but they need to focus on building a moat, which allows them to have better and more consistent profits than they have right now.

Understandability Rating: 2 / 5

While Netflix’s core business of providing streaming content is straightforward, the industry dynamics with multiple overlapping and interwoven factors, along with the complexity of content creation, licensing, production, and multiple international regulations, makes this a bit more complex than a typical business, even for professionals.

Balance Sheet Health Rating: 4 / 5

Netflix has good liquidity, a decent balance of assets vs liabilities, positive free cash flow, and very little leverage and upcoming debt maturities. These all point to the company having a healthy financial position.