Netflix Inc.'s (NFLX, Financial) share price has declined 47% from its highs of up to $671 per share in November 2021. The company has faced an intense battle in the streaming wars, which has resulted in their market share being eaten up, going from 51.4% at the end of 2020 to 43.6% by the end of 2021. Moreover, it is reaching market saturation in its home market, the U.S.
Not everyone is selling, though. Bill Ackman (Trades, Portfolio) of Pershing Square Holdings (LSE:PSH, Financial) saw this volatility as a buying opportunity and disclosed in his letter to shareholders for 2021 that he had invested the “proceeds of a hedge,” which equate to approximately $1.2 billion, into Netflix stock near the end of January. The estimated buy price of this trade was $395 per share, which is 12% above the current price of $341 per share.
According to the letter, Ackman believes Netlifx is a “high quality business overseen by a world class management team." Their product offering is “80% less expensive than the average Pay TV package in the USA” and they have the “lowest churn rate by a wide margin amongst streaming services."
In this article, I'll break down the five main reasons why I think Ackman likes Netflix.
Source: Ackman's 2021 letter to shareholders
1. Secular growth ahead
Netflix is poised to benefit from the growth in the subscription video market, while benefiting from the "secular decline" in PayTV packages.
The streaming market size is forecasted to continue to grow by an 18.3% compound annual growth rate (CAGR) up until 2026. PayTV subscriptions were 100 million in 2014 and are expected to decline by 40% to just 60 million by 2026.
2. Pricing power
Netflix offers one of the lowest cost forms of high value entertainment, and their service is still 80% cheaper than the average PayTV package in the U.S., with a 30 cent cost per engagement hour. With the average PayTV subscription package being $80, customers could pay for multiple streaming services and it would still be cheaper!
Netflix has also shown itself to have “pricing power” in the industry and has recently increased prices again, but they are still cost effective.
3. Netflix still leads
Netflix is still the market leader but is facing intense competition from rivals. It has seen its market share decline from 51.4% in 2020 to 43.6% in 2021 while rivals such as Apple (AAPL, Financial) TV, Warner Bros. Discovery's (WBD, Financial) HBO Max and Disney+ (DIS, Financial) have grown their market share anywhere between 13.5% and 21.4%.
Netflix has also seen slowing user growth with a net increase of 8.28 million subscribers reported in the fourth quarter of 2021, which was mainly driven by markets outside of the U.S. However, this was below the company’s prior guidance of 8.5 million paid subscribers and even analyst expectations of 8.3 million.
4. Strong financials
Netflix generated $29.7 billion in revenue in fiscal 2021, up a substantial 18% year-over-year, while gross profit increased a substantial 26% from $9.7 billion in 2020 to $12.3 billion in 2021.
Gross profit margins have increased from a healthy 38% in 2020 to 40% in 2021. Operating profit margins have been on an upward trend, increasing from 12% to 20.86%. As of the end of fiscal 2021, Netflix has $6 billion in cash and cash equivalents with current debt of just $699 million. I noticed their long-term debt of $14.6 billion could be an issue if interest rates rise.
5. Attractive valuation
The GF Value Line, a unique intrinsic value estimate from GuruFocus, shows that Netflix stock is cheap - so cheap, in fact, that it has been flagged as a possible value trap.
In terms of relative valuation, the stock is trading at the lowest price-sales ratio (5.4) and lowest enteprise-value-to-Ebitda ratio (8.7) since 2016.
Final thoughts
Netflix is a fantastic company, and despite the increasing competition, they are still the market leader in streaming. Their service acts as an “anchor” for the rest of the market. Netflix’s competitors are pouring huge sums into the “streaming wars,” but they are not profitable on a standalone basis, as Ackman points out in his letter. Thus, if they don’t start generating a significant return, they may redirect their funds to other bets in the future, which is an optimistic outlook for Netflix.
The company currently looks undervalued, and earnings per share is expected to grow by up to 20% per year according to Wall Street. I do expect volatility moving forward, and Netflix has to prove they can still grow subscribers, but in the long-term, this stock is worth tuning in for.
