“Netflix’s fundamental business model seems unsustainable,” said Aswath Damodaran, a New York University finance professor, who has examined the company’s numbers closely. “I don’t see how it is going to work out.”
With increased competition looming in streaming video, he said, Netflix must keep spending enormous sums on content and marketing. If it cuts spending, he said, it is likely to lose much of its precious audience.
“Sure, the company is growing rapidly now,” he said. “It has an amazing number of new movies and TV shows. For a consumer, that’s great. But for an investor, it’s a different story: The more Netflix grows, the more its costs grow and the more money it burns. I’m not sure how it’s ever going to turn that around.”
Professor Damodaran posted a valuation model for Netflix on
his blog, as an instruction tool. His
model is based on a straightforward, well-established method — the
discounted cash flow approach used by investment analysts around the world. At my request, he plugged the company’s latest numbers into that model to figure out what Netflix’s shares appear to be really worth. The results were startling.
The company’s shares, in his estimation, are worth buying as a serious investment only at about $177. But Netflix has been trading around $310 a share lately, after surpassing $400 earlier this year.
In a nutshell, the problem is the disparity between money in and money out — and Professor Damodaran’s presumption that Netflix’s costs must remain high, if it is to keep growing.
Netflix’s cash-flow statement indicates that in the 12 months through September, it spent $11.7 billion on new content. But its income statement indicates that total revenues were $14.9 billion, leaving it only about $3.2 billion to pay for marketing and the rest of its operations. That wasn’t enough to run the business, so the company has borrowed money.
On Monday, Netflix
announced that it intended to borrow more, by selling $2 billion worth of bonds, which rating agencies
say is below investment-grade. That comes on top of $8.3 billion in speculative-grade debt already on its balance sheet. The borrowing is likely to continue to grow as long as the company burns cash faster than its millions of subscribers send in money.
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