D.j. Dexter

Financial Statement Analysis

Ty Perry

Semester Project

Financial Statement Analysis Project

Netflix

Netflix is the worldwide leader in Internet television and DVD streaming. The

company has more than 33 million subscribers in more than 40 countries. Netflix

subscribers watch more than one billion hours of content per month. Netflix has original

series’ that are exclusive to only Netflix subscribers. Although they are moving away

from the idea, Netflix also delivers DVDs to the homes of the subscribers. Netflix’

revenue from the most recent financial statement was 3.61 billion. The company has

2,045 full-time employees as well as 384 part-time employees. As of February 27th the

Market Cap. (Market value of equity) was 10.33 billion.

Netflix has three main business segments: Domestic streaming, International

streaming, and Domestic DVD. The International and Domestic streaming segments get

their revenues from monthly subscription services that consist of streaming content. The

Domestic DVD segment derives its revenue from monthly subscriptions that consist only

of DVD-by-mail. In 2012 the Domestic streaming segment of Netflix had revenues of

$2,184,868,000. The Domestic DVD segment had revenues of $1,136,872,000 in 2012

totaling $3,321,740,000 for total domestic revenues. As for the International segment of

Netflix, the revenues for 2012 were $287,542,000.

Netflix’ core strategy is to grow a streaming subscription business domestically

and internationally. With a new main focus on expanding the streaming content of the

company, as well as enhancing the user interface and extending the streaming content to

even more apps and devices, they are continuously enhancing the customer experience.

The biggest move they have made in recent years has been shifting spending away from

the Domestic DVD segment so that they can invest more in streaming content and

marketing their streaming services.

Being the world’s leading Internet television network with over 33 million

members, it is needless to say that Netflix has many strengths. In this day and age

Netflix is a staple in not only streaming content, but in home entertainment. If you were

to ask people the first thing they think of when they hear TV or movie streaming, 9 out of

10 will say Netflix. They have a competitive advantage over any other streaming

company in that they have the most premium content as well as in my opinion the best

user interface. Not only does Netflix have a wide range of premium content but they also

have exclusive original content (House of Cards, Arrested Development) that sets them

apart from their competition. With that being said, Netflix, like any other company, has

weaknesses as well. The biggest weakness that I see for Netflix is their International

business segment. Going international is necessary for large growth in the company, but

it is also risky. For the 2012 fiscal year, the international streaming segment recorded a

$389,311,000 contribution loss. If the consumer base does not grow at the rate they want

it to it could be very detrimental to Netflix. Another weakness of Netflix is that

customers are currently able to access their account from multiple devices. This allows

many people to use the same account as opposed to each of these people having their own

account. Although convenient to many subscribers, this is causing Netflix to miss out on

many potential subscribers and in turn slowing growth.

It may seem that Netflix can’t get any bigger, but it can. They have recently

acquired the rights to Disney beginning in 2016. This is a huge opportunity for them to

not only retain current subscribers but also to obtain new ones. With Disney recently

buying the Star Wars franchise, Netflix will have the rights to every Disney movie as

well as the rights to the Star Wars franchise and the Marvel franchise. Although I believe

that the international streaming segment of Netflix is currently a weakness, I also believe

that this can be a big opportunity for them if they can execute properly. This is their

greatest chance to grow the company, but to do so they must market well in order to

make the company a household name like it is in the states. If they are able to effectively

use the investments that they are putting forth in foreign streaming content and marketing

today, they may be able to grow their subscriber base and grow revenues while shrinking

expenses.

Today, the biggest threat to Netflix is Amazon. Amazon is Netflix’ biggest

competitor with the ‘Amazon instant video’ program. The reason that I believe Amazon

is Netflix’ biggest threat is not because they have a competitive advantage over Netflix,

but it is because Netflix uses Amazon’s web services (AWS) for a distributed computing

infrastructure platform. If Amazon wanted to, they could use the AWS to gain a

competitive advantage over Netflix.

Top Executives of Netflix

Name Title# of Options

Value of Options Salary

Reed Hastings CEO 1,703,824 $42,967,600 $500,000

David WellsChief Financial Officer 16,322 $1,112,784 $411,058

Tawni Cranz Chief Talent Officer NA NA NA

Neil HuntChief Product Officer 81,905 $7,302,831 $994,872

Theordore Sarandos

Chief Content Officer NA $4,860,000 $917,000

(Businessweek.com)

Snapshot

Current Stock Price 216.72Earnings Per Share 0.29P/E Ratio 736.53Dividend Yield N/A

(April 24th,2012) Yahoo Finance

When Netflix’ quarterly report came out on April 23rd the stock price leaped from

173 to 215 overnight. Since then the price has remained between 210 and 220. They are

reporting earnings per share at nearly .3 and price to earnings ratio of 736.53. Netflix

does not pay dividends so obviously there is no dividend yield.

Shares Outstanding 55.99M

Avg Vol (3 month) 5,708,180Avg Vol (10 day) 7,030,3602013 annual earnings estimate 1.322014 annual earnings estimate 2.872013 earnings growth rate estimate 355.20%2014 earnings growth rate estimate 117.40%

(Yahoo Finance)

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Netflix Stock price 2012

As you can see from this chart, Netflix is a very volatile stock. Prior to 2012 in the

summer of 2011 the stock price of Netflix was over $300. After the “quickster” debacle

where Netflix planned on splitting into two separate companies, the stock price

plummeted to around $50 dollars per share. It came back up in the begging of 2012 and

has been extremely volatile through the duration.

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Netflix Stock Prices 2013

After another year of the stock price dropping drastically to below $50 per share,

Netflix seems to be doing very will this year. The spike that you see in January from

$100 to over $150 per share is what is known as a short squeeze. Prior to the earnings

report, many people shorted the stock thinking the price would fall. However, the

earnings report exceeded expectations to say the least and in an effort to cut their losses

investors who shorted the stock sold it as quickly as they could. Since then the price has

fluctuated between $200 and $150, which again is extremely volatile. The first quarter

earnings report came out in April, and again, it exceeded expectations resulting in a more

than $20 spike overnight. Since then, the price of the stock has been in between $210 and

$220 per share.

Netflix Major Stock Holders

Share Holders Shares Percentage of total shares Value ReportedIcahn, Carl, C. 5,541,066 9.9 513,047,300 31-Dec-12Price (T.Rowe) Associates Inc 4,795,383 8.56 444,004,511 31-Dec-12Davis Selected Advisers, LP 3,937,721 7.03 364,593,587 31-Dec-12Vanguard Group, Inc. (The) 3,342,699 5.97 632,706,066 31-Mar-13State Street Corporation 2,249,379 4.02 208,270,001 31-Dec-12BlackRock Institutional Trust Company, N.A. 1,523,186 2.72 288,308,646 31-Mar-13

Goldman Sachs Group, Inc. 1,518,397 2.71 140,588,378 31-Dec-12Slate Path Capital, LP 1,330,000 2.38 123,144,700 31-Dec-12Coatue Management, LLC 1,277,633 2.28 118,296,039 31-Dec-12Capital Research Global Investors 6,683,485 11.94 618,823,876 31-Dec-12

(Yahoo finance)

The “Float” for Netflix is 49.63 million shares. 46.63/55.99 = 88.63% of shares are

outstanding and available for trade.

Comparative Analysis

2010 2011 2012NFLX

AMZN

CSTR

NFLX

AMZN

CSTR

NFLX AMZN

CSTR

Liquidity RatiosCurrent ratio 1.65 1.33 0.77 1.49 1.17 1.36 1.34 1.12 0.99Cash ratio 0.49 0.36 0.29 0.41 0.355 0.72 0.17 0.43 0.5

Solvency RatiosTotal debt to asset ratio 1.42 0.63 0.65 1.27 0.69 0.64 1.23 0.75 0.65

Times Interest earned 13.4 38.4 3.11 18 14.37 7.11 1.5 5.912.7

3

Profitability 0.37 0.220.30

2 0.36 0.2240.30

5 0.27 0.2470.31

7

Gross margin 0.13 0.040.09

9 0.12 0.0180.11

3 0.01 0.0110.11

9

Net margin 0.07 0.034 0.04 0.07 0.013 0.06 0.005

-0.0000

6 0.07

Return on Common

EquityROE 0.68 0.87 0.11 0.53 0.32 0.19 0.04 -0.02  .22

(Morningstar.com)

I chose Amazon and Coinstar as Netflix greatest competitors. Amazon, because

they have a similar online streaming service that is trying to compete with Netflix. And

Coinstar, because it owns Redbox. I would have like to choose Hulu because I think they

are a stronger competitor than Coinstar, but they are not yet publically traded.

Liquidity Ratios

Liquidity ratios focus on a company’s ability to pay off debt when due. Or, in

other words, their ability to turn assets into cash and how quickly they can do so. The

current ratio shows how the company could meet short-term obligations if sales stop.

Netflix has current ratios of 1.69, 1.45, and 1.34, all of which are greater than Amazon’s

and Coinstar’s in each of the three years. The cash ratio is the ratio of a company’s total

cash and equivalents to its current liabilities. This ratio is normally used for determining

how fast a company can pay off its short-term debt. This is definitely a conservative

approach to valuing a company’s liquidity. The cash ratio does not take into account

accounts receivable or inventory so it is not a great tool for measuring a company’s value.

Netflix has cash ratios of .49, .41, and .17 respectively. There isn’t really a “norm” for

cash ratios but I would say that a cash ratio above .2 is acceptable. Netflix cash ratios in

2010 and 2011 are good in comparison to Amazon’s. Coinstar did record a higher cash

ratio than Netflix in 2011 by .31. However, in 2012 Netflix had a low cash ratio of .17.

This is because they invested heavily in international streaming, Amazon and Coinstar

recorder better cash ratios than Netflix that year. Again, only so much can be taken from

this ratio since it does not take into account inventory or accounts receivable.

Solvency Ratios

Total debt to asset ratio is a measurement of the company’s financial risk. It is

basically showing how much of the company’s assets are financed by debt. Netflix has a

fairly high total debt to asset ratio in all three years. Amazon and Coinstar’s ratios are

much lower and fairly equal to each other. These company’s seem to be much less risky

financially. The times interest earned ratio shows the company’s ability to repay its

interest and debt. Netflix reported fairly high ratios in 2010 and 2011 of 13.4 and 18. The

ratio 13.4 was greater than Coinstar’s yet smaller than Amazon’s but the ratio of 18 was

greater than both. However in 2012 they reported a ratio of 1.5, which is so low because

of the heavy investments in international streaming. Amazon and Coinstar had better

ratios than Netflix in 2012.

Profitability

The gross profit ratio shows the proportion of profit that the company receives

from each dollar. In 2010 and 2011 Netflix reported great gross margins of .13 and .12

(13% and 12%). These were much better than those of Amazon and Coinstar. However,

once again in 2012 it was much lower at .01. This was still only slightly lower than their

competitors. Netflix net margin was greater than Amazon’s in all three years and was

only less than Coinstar’s in 2012.

Return on Equity

Return on equity basically shows how much profitability the company is

generating from the money shareholders have invested. Netflix return on equity was good

through 2010 and 2011 and fell sharply in 2012 to follow the pattern. However the only

time it’s competitors showed a higher ROE was Amazon in 2010 and Coinstar in 2012.

2010 2011 2012ROE 0.68 0.53 0.04

The 4% value that I got for 2012 will be one of the estimates I use for my required rate of

return.

Capital Asset Pricing Model

CAPM2012

NFLX AMZN CNSTROE 0.04 -0.02 0.22

BETA 1.11 0.82 0.77Rm 0.11 0.11 0.11Rf 0.04 0.04 0.04Ri 11% 9.7% 9.4%

(Yahoo Finance)

Using the Capital Asset Pricing Model I was able to calculate my required rate of

return using beta, the risk free rate, and the market rate. The value I got for my required

rate of return was .110018 which I rounded to 11%. This is quite a bit bigger than the

estimate used from the return on equity and I believe that this estimate is much more

accurate.

Historical Growth Rates

Growth Rates 2011 2012Revenue Growth Rate 48.20% 12.60%Net Income Growth Rate 40.40% -92.50%

Operating Cash Flow Growth Rate 15.20% -92.70%Investing Cash Flow Growth Rate 11110% -98.66%Free Cash Flow Growth Rate 55% -137%

Above are my calculations for growth rates in 2011 and 2012. As you can see the

growth rates changed drastically from 2011 to 2012. The main reason that the growth

rates are so high in 2011 and so low in 2012 is that Netflix tends to invest a lot of money

one year and see the return in the next year. So, in 2010 they invested heavily in their

different segments and in 2011 they saw the growth that they hoped for. In 2012 they

invested heavily again which made their growth rates plummet but they expect them to

climb again in 2013.

Value Line Future Growth Rates

Value LineEst. 09-11 through 12-15

Annual RatesRevenues 17.50%Cash Flow 25%Earnings 7%

(Jim Villeta Value line report)

Above is what the value line estimated for the company’s future growth rates in ,

revenues, cash flows, and earnings. These growth rates are pretty high and will likely

cause me to adjust the growth rate when valuing the company’s equity.

Long-term sustainable growth rates

2010 2011 2012ROE 0.68 0.53 0.04Plowback 1 1 1Long-term sustainable growth rate 0.68 0.53 0.04

Above are my calculations of the long-term sustainable growth rates for the past

three years. As you can see, they are all equal to the return on equity. This is because my

plowback ratio or “retention rate” is equal to 1 since Netflix does not pay dividends.

Again, 2012’s long-term sustainable growth rate is significantly smaller than the previous

years due to the heavy amount of investing. This is another factor I will take into account

when adjusting my growth rate and required rate of return.

Growth Rate and Required Rate of Return

In calculating my long-term sustainable growth rate I got .04 or 4% for 2012. This

differs greatly from the previous two years when they recorded growth rates of 53% and

63% respectively. My historical growth rates that I calculated were all very low and all

but one were in the negatives. I believe that this information is skewed due to heavy

investing in international streaming. The year prior all of their growth rates were very

high, which leads me to believe that the growth rate will bounce back in 2013. The value

line had future growth rates valued at 17.5% for revenues, 25% for cash flows, and 7%

for earnings. These numbers seem healthy and I agree with these much more than I do

with using the historical growth rates. It seams that there is a trend with Netflix that

every other year their growth goes up very high then down and in 2012’s case, down very

low. I believe that the growth rate is going to shoot back up again, mostly because I

believe the money they are investing in international streaming is going to pay off and

they will see that segment grow largely. Also the value line predicts good growth in

revenue, cash flow, and earnings. In the 10-k they talk about how expanding their

international streaming segment is their greatest opportunity for growth. This is

encouraging seeing that they are investing so much money into it. Taking all of these

factors into account, I am adjusting the growth rate to 11%. One of the reasons I am

doing this is because of the growth rates I got from the value line. I think according to

those future rates 11% is appropriate. Another reason why I chose 11% is because

analysts opinions on yahoo finance say that the growth of Netflix will be very close to the

required rate of return. I will come back to this.

For the required rate of return I first used my return on equity to estimate this and

the number I used was .04 or 4%. I then used the capital asset pricing model or CAPM to

calculate my required rate of return and the number that I came up with was 11.0018%,

which I rounded to 11%. The required rate of return that I am choosing to use is the

number I calculated from the CAPM which was 11.0018%. I think that this number is

more accurate because the 4% that I received for 2012 seemed skewed downward due to

the investments in international streaming. I believe that they will see greater returns in

2013. I took 1/p/e ratio and it gave me a very low number, which is going to be my r-g.

This means that the difference between my return and growth is going to be very minute.

So, this is another reason why I am going to use 11% as my growth rate and I am going

to use the original number that I calculated from the capital asset pricing model which

was 11.0018% (I am not going to round this number because return needs to be higher

than my growth rate). I believe that these numbers may give me a fairly accurate estimate

of the company’s equity, and further, the company’s share price.

Free Cashflow to Equityholders

Free Cash Flow to EquityholdersOperating Cash Flow 23Investing Cash Flow -2.61Net New Borrowings -1.78FCFE 18.61

FCFE (2012) 18.61Growth Rate (Adjusted) 11.00%FCFE (2013) 20.66Required Rate of Return (adjusted) 11.0018%r-g  .0018Value of firms equity (today) 11476

Share price 204.97(10-k)

I calculated the free cash flow to equity holders by using operating cash flows,

investing cash flows, and net new borrowings. I then used the growth rate to compute the

free cash flow to equityholders for next year, which came to 20.66. By taking that

number and dividing by r-g (.0018) I was able to compute the value of the firm’s equity. I

then took that number and divided it by the number of shares outstanding and that

number was what I came up with for the share price.

204.97 is my estimate for the current market price. The actual current market price is

227.29. I think that this estimate is pretty accurate for such a volatile company that

does not pay dividends. I believe my adjustments helped keep my estimate close.

Capitalization Rate Matrix

20.6610 0.10 0.11 0.12 0.13 0.14 0.15 0.16 0.17

0.01 229 207 188 172 159 148 138 1290.02 258 229 207 188 172 159 148 1380.03 295 258 229 207 188 172 159 148

GROWTH 0.04 344 295 258 229 207 188 172 159

RATE 0.05 413 344 295 258 229 207 188 1720.06 516 413 344 295 258 229 207 1880.07 688 516 413 344 295 258 229 2070.08 1033 688 516 413 344 295 258 2290.09 2065 1033 688 516 413 344 295 2580.10 2065 1033 688 516 413 344 2950.11 2065 1033 688 516 413 344

In the yellow cell above I entered the number that I calculated for FCFE 2013.

The capitalization rate that is shown is 9%. This shows that my r is going to fall

between .10 and .17 and my g will be between .01 and .11. The numbers diagonally

highlighted are the numbers that are the closest to the market value of Netflix share price

currently. I believe the closest combination of r and g shown here would be the .12 r

and .03 g. Although the g does not seem very close, (I calculated a growth rate of .11) it

is close to the growth rate I estimated from my ROE which was .04. I am not exactly sure

why this is the case seeing as though my adjusted growth rate gave me a much more

accurate share price estimate, but never the less it shows that the ROE estimate could

have been used as well. That being said, I think that this capitalization rate is fairly close

considering the volatility of Netflix stock.

Conclusion

To say that Netflix is an interesting company would be a large understatement. It

is the largest television streaming company in the world and is a staple in home

entertainment in America. Its main goal currently is to expand their international

streaming service and they are shooting for the moon by investing a lot of money into it.

There seems to be a pattern with Netflix where they spend a lot of money one year and

see very low growth and the next year the growth is off the charts. This is what I see

happening in 2013. 2012 was a strange year for them, their growth was extremely low

(mainly due to heavy investing internationally), yet when their earnings report came out

the price of the stock shot up. In terms of the stock, it is extremely volatile. Netflix is

very sporadic and has gone from 300 dollars per share to 50 in the blink of an eye.

Currently it is right around 230, which is higher than most analysts had imagined at the

end of 2012. The two competitors that I chose to focus on where Amazon and Coinstar. I

believe that Netflix had better ratios than it’s two competitors from a horizontal

standpoint. However, looking at 2012, they look much worse. The rate of return that I

calculated and believe is the best estimate is 11.0018%. I calculated this percentage using

the capital asset pricing model. The growth rate that I believe is the most appropriate is

11%. By taking 1/P/E I got a very low decimal which I believe should be the difference

between return and growth for this company. Prospective growth is very high since this is

a volatile and financially risky company. Finally, the estimate I calculated using my r and

g for current market price was 204.97. The actual current market price is 227.29. My

estimate was off by about 9.5%. I think that this is pretty close when taking into

consideration the fluctuation in the price day to day and the overall volatility of the firm.

References

Netflix 10-k

Value line report

Bloomberg. N.p., n.d. Web. 13 May 2013.

Businessweek.com

"Morningstar Stock, Mutual Fund, Bond, ETF Investment

Research." Morningstar Articles RSS. N.p., n.d. Web. 13 May

2013.

Appendix

Financial Statement

Balance sheet

Statement of Cash Flow

Financial Statement Analysis Project

Douglas DexterFMIS 3641

Ty PerryMay 2013