Industry Consolidation and Internal Initiatives Will Support Subscriber growth

Continued Solid Member and Revenue Growth, Plus Cost Controls - Upgrading my Valuation.

Overall, Netflix had another solid quarter, and is tracking slightly ahead of my estimates. Revenue growth, member growth and margins are tracking better than I expected, while cost controls are largely in line with my estimates.

My original narrative was over a year old, so I have rebased my valuation to be a new 5 year estimate, and this has increased my fair value estimate from $627 to $797.

Assumption 1: Subscriber growth will continue at 10% per year

Same as last quarter, Netflix is outperforming my expectations for this assumption.

The company had subscriber growth of 14.4% YoY, still ahead of my 10% estimate. This means they added 5.07m members to reach 282.72m paid memberships. If this growth rate continued, it would reach around 553m subscribers by September 2029. As mentioned last quarter, I may be wrong, but I believe that kind of growth rate will be hard to sustain.

I originally estimated 10% growth in members per year. If we continue that 10% annual growth rate from today (282m subs), that would be 454m subscribers by September of 2029, which is 20% higher than my prior 380m estimate for late 2028.

As mentioned last quarter, I still think the strong growth will slow down as the initial benefits of the paid sharing and ad-plans rollout subsides. But that doesn’t mean it won’t be able to achieve a higher ARPM by that time due to higher Ad revenue and price increases, which I think it will.

Considering this is the 2nd last quarter where they will be disclosing ARPM and subscriber numbers, it will be hard to accurately assess these metrics in 5 years time (unless they pass a milestone, in which case, they’ll announce it).

So while this won’t be my primary metric going forward, I estimate that Netflix will reach 454m paying subs by September 2029 (10% p.a. growth).

Assumption 2: ARPM To Rise at 5% per year, and revenue to grow at 13%

Like last quarter, I am currently underestimating this one, since revenue and ARPM are growing faster than expected.

Revenue of $9.825bn for the quarter from 282m subscribers is $34.8 in revenue per member for the quarter. If we annualize this, we get $139.3, which is $11.6 per month. Global ARPM last quarter was $11.5/month, so this has been mostly flat.

Revenue grew 15% YoY which was slightly ahead of my 13% estimate. The ads business is still scaling well with 35% growth in memberships quarter on quarter. It’s ad tech platform is on track to launch in Canada in Q4, and more broadly in 2025. The out-performance in terms of revenue can be attributed to adding more members than I expected.

The thing is, the ads plan so far has only started rolling out to the US, Australia and Brazil. The US and Australia have higher ARPM than the rest of Netflix’s markets (countries in APAC, LATAM and EMEA)

When it starts expanding into other regions around the world, where its existing ARPM is lower, I imagine it won’t be able to charge as much in these regions for the ad plans as it does in more developed regions. So despite the ads plans have strong adoption from users, I still believe ARPM will drop in the near term when ads are rolled out more broadly.

With this being the case, and having just rebased my narrative, I believe that ARPM will decline in the short term, and rise, on average, by 2% per year over the next 5 years (down from my prior 5% estimate). That means I estimate it will reach $153 per year by September 2029, leading to $69.67bn in overall revenue from the 454m subs.

Assumption 3: Content Costs And Operating Expenses To Stabilise

This assumption is largely on track. The expense of “Additions to content assets” totalled $4.016bn this quarter, the same as last quarter, and higher than Q3 last year at $3.5bn. On an annualized basis, that's still only $16bn, below their guidance of $17bn.

The company guided to roughly $17bn run rate of content spend per year, and seems to be managing with even less than that, at least for this past quarter.

Even if they do start increasing this spend at 5% as I originally expected, the revenue growth should continue to outpace this content spend growth, and therefore its % of revenue should continue to stay around 40%, and net margins should increase.

The Cost of Revenue expense (primarily the amortisation of content spend, plus acquisition, licensing and production of content) was 52% of revenue, down from 57% for 2023, and 61% in 2022. As revenue grows at a faster rate than their content spend as they scale, I expect this % to continue to reduce.

As for the operating expenses (Technology & Development, Marketing and General & Admin), these expenses have remained relatively steady as a % of revenue. T&D has stayed at 6.5% of revenue this quarter. Marketing is down from 7.6% to 6.5% this quarter, while General and Admin declined, from 4.9% a year ago to 4.2% now.

These have almost all reduced past my initial estimates of 7%, 7% and 4% of revenues by 2028, respectively. Management could either choose to increase there spend here given the strong revenue growth, or I will have to increase my net margin estimate slightly in a few quarters if they don’t.

All these efficiency improvements from more scale and operational leverage are flowing through to the bottom line, which leads me to my next assumption.

Assumption 4: Profit Margins To Expand from 13% to 20%

This assumption is largely on track, and slightly better than I expected.

I originally assumed that net profit margins would increase from 13% to 20% by 2028. But for Q3 already they’re sitting at 20.7% on a TTM basis, and 24% for the quarter.

This is really encouraging to see, and shows that the continued steady revenue growth, aligned with cost discipline is all flowing through to the bottom line and quicker than I anticipated. 

As mentioned last quarter, if the company seems likely to reach 25% net margins by year-end, which they’re anticipating. Based on management commentary, and improving operational efficiency, it seems likely to achieve operating margins around 30%. I believe that my profit margin estimates of 20% by 2029 may be too conservative. So I’m going to increase my net margin estimates from 20% to 25%, given NFLX’s net income seems to be around 85% of operating income (income before interest and taxes).

With this in mind, that this changes my FV quite a bit. If I assume 25% net income margins on $69bn in revenue, that delivers $17.25bn in earnings in 2029, instead of my original $10.56bn earnings estimate for 2028. With a 30x PE on $17bn in earnings, this would be a $517bn market cap in 2029. Dividend by 427m in shares outstanding, this equates to $1,210 per share. Discounted back at 8%, per year, that means my new FV estimate is $797 per share.

Overall, the business is still performing very well, and on track or ahead of my estimates. My conviction in the business has grown as I’ve watched it and got to know it better. It’s just unfortunate that the market has come to appreciate its strength faster than I have, meaning I’ve been slightly underestimating it’s potential over the last few years.