Could Netflix Become Buffett’s Next Stock?

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netflixit is (NFLX -6.36%) the results for the first quarter of 2022 shocked its shareholders.

The company said it lost 200,000 subscribers – its first such drop in more than a decade. And due to the turmoil created by Russia’s invasion of Ukraine, Netflix has warned it could lose an additional 2 million paying customers in the second quarter.

The results forced many investors to sell their stock, plunging to its lowest price since 2017.

But ignored by most, the streaming giant leaked two “golden nuggets” of valuable information:

  1. Offering a free, ad-supported streaming channel, possibly in Q4, according to leaked internal memos and comments from CEO Reed Hastings.
  2. Executives told analysts they expect their company to achieve a major financial milestone this year, generating consistent positive free cash flow (FCF) for 2022 and beyond.

As unlikely as it may seem now, with the stock down 75% from last year’s highs, these announcements could turn the stock into a type of holding often prized by long-term investors like Warren Buffett.

Image source: Getty Images.

The Anatomy of a “Buffett Stock”

Most of Buffett’s businesses Berkshire Hathaway wallet – think about Apple, disney, Coca Cola, et al – sell products or services that change little from year to year. But customers keep coming back for more.

As a result, most of Buffett’s businesses have stable earnings, but also low debt while generating a steady stream of excess cash that can be funneled back into the business for future growth.

Then there’s Netflix.

For most of the past decade, the company has been spending big on cutting-edge shows and movies. In turn, these programs attracted millions of new subscribers and generated a steady stream of profits.

But the flow of money from subscription fees has never been enough. Over the past 10 years, Netflix has spent an average of $860 million more annually than it has earned.

The company did the rest by tapping into the bond market. Between 2015 and 2020, Netflix increased its level of long-term debt by 600%. As of the first quarter of 2022, it still owed $14.5 billion to bond investors (more details below).

For Netflix, the problem is that once a hit series ends, the company has few options (other than a small revenue stream from DVD sales) to rebroadcast the same show to a new audience and be paid for it.

An ad-supported streaming channel gives Netflix a “buffet-style” way to generate recurring revenue long after a program has lost its buzz-worthy status. According to some estimates, a Netflix “free channel” could bring in as much as $2-3 billion a year in additional revenue, and that’s just getting started. It is money that the company can use to pay down its debt or buy back its own shares.

Recent studies point to massive growth in ad-supported streaming. The market has grown by more than 20% in each of the past two years and will likely triple in size to over $31 billion by 2026.

For Netflix, one way to compare the possibilities is to look at the average revenue per subscriber — $14.91 — according to its Q1 2022 results. Roku (ROKU -6.14%) an ad-supported free streaming competitor generates an average revenue of $42.91 per user, nearly three times as much.

Will 2022 be the financial turning point?

Still, Netflix executives say their company is already on track to hit another Buffett-worthy milestone this year: consistently positive FCF.

During the company’s first quarter 2022 conference call, Chief Financial Officer Spencer Neumann told analysts “We will [have] positive free cash flow this year…and we’ll continue to build on that in the years to come.”

Why is this a big problem?

Companies that generate a lot of cash year after year like walmart, Exxon, and other blue chip companies achieve investment grade credit ratings. So they have very low borrowing costs.

As successful as Netflix is ​​as a business, its bonds are still rated as waste by analysts from Moody‘s.

But in a nod to Netflix’s growing financial strength, the credit-rating company said in April that it would likely upgrade Netflix’s bonds to investment grade in coming quarters as it demonstrates ” new levers to increase revenues and free cash flow”.

What about Netflix stocks?

Netflix shares will likely continue to be weak in the near term. But the company is still very profitable.

Analysts expect the company to post slightly lower earnings of $10.94 per share this year, about 3% below 2021. Part of this decline is due to increased competition for new subscribers from competitors. streaming like Disney, Primordial, and others. Netflix also lost Russia as a source of new subscribers due to the war in Ukraine.

Still, if we divide Netflix’s stock price (about $170 at the time of this writing) by the company’s projected annual earnings for 2022, that gives the stock a price-earnings ratio of 15 – its level of lowest valuation since obscurity. days of the 2008 US financial crisis.

Looking to 2023, analysts expect Netflix earnings to resume a double-digit annual percentage growth pattern, reaching $12.62 and rising further to $15.30 in 2024.

If we put it all together, the company’s financial situation is steadily improving, alongside the promise of an ad-supported free-to-air channel by the end of this year.

Combine these developments with the stock price’s sharp drop to “stock value” status, and Netflix could potentially attract a lot more attention from investors, including Buffett.

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