Netflix (NASDAQ: NFLX) once stated its goal is to become HBO faster than HBO can become it. Netflix has transformed from a DVD-by-mail service, to a way to deliver reruns over the internet, to a full-fledged modern television network all in the span of a decade. There's no question the Netflix of today is a media company in the same vein as Disney (NYSE: DIS) or HBO parent company Time Warner (NYSE: TWX).
And following Netflix's surprise price increase and better-than-expected third-quarter results, the market is valuing it more highly than just about any other media company. Disney, with its huge intellectual property portfolio and theme park business, is the only media company with a bigger market cap than Netflix now. But does Netflix deserve such a high valuation?
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How does Netflix stack up?
See the table below to see how Netflix's market cap compares to other media companies.
Netflix isn't just bigger than most media companies; it's a lot bigger.
That's an impressive feat for a company with only one real business. (Netflix's DVD-by-mail business is slowly fading into irrelevance.) Disney, Time Warner, Twenty-First Century Fox (NASDAQ: FOXA), and CBS all operate multiple media businesses, including some combination of television, film, and radio.
Time Warner is the most oft-compared company to Netflix because of the similarities to HBO. But Time Warner also owns Turner and Warner Bros. To be sure, Netflix is a bigger and faster-growing company than HBO, but HBO's parent company brought in nearly three times as much revenue as Netflix through the first half of 2017. What's more, Time Warner produced nearly 10 times the net income of Netflix. Even HBO's operating income was nearly three times that of Netflix.
The point is all of Netflix's market value is based on the idea that it will continue to grow rapidly and produce significant profits at some point in the future.
Will Netflix grow into its valuation?
Netflix's valuation is off the charts compared to the other big media companies.
Netflix needs to grow its earnings more than 10 times over the next few years to justify its current valuation.
The good news is, that kind of growth is completely within the realm of possibility. Analysts expect Netflix's earnings to grow an average of 69% over the next five years. At that pace, the company will increase earnings 13.8 times by 2021. Time Warner, by comparison, is expected to grow earnings less than 10% per year over the next five years.
In order to meet those marks, Netflix will eventually have to slow down its investments in content. Management said it could spend as much as $8 billion on a profit-and-loss basis next year, up from $6 billion this year.
It also must continue exercising its pricing power. Netflix has steadily raised prices in its mature markets over the last three years, but it still has room to increase prices further both domestically and internationally.
The newest lever Netflix is pulling is moving further into merchandising. As Netflix produces more of its content in-house, it's able to retain the intellectual property and license it to merchandisers.
Disney generates around $5.5 billion per year from its consumer products and interactive media segment, which is generated primarily from licensing its intellectual property. For reference, Netflix made $8.8 billion total all of last year.
Netflix can certainly grow into its current valuation given all the levers it has to pull and its rapid subscriber growth, but it's certainly a lot riskier at this price than a company like Disney.
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Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix and Walt Disney. The Motley Fool recommends Time Warner. The Motley Fool has a disclosure policy.