Netflix: Levered Buyback In The Cards?

All it took was a $1,000 stock price to finally convince people Netflix is a great business with strong prospects. Fourth-quarter results were great but they’ve been great for a while.

I’m going to assume you’ve read the shareholder letter and listened to the call or read the transcript so I won’t rehash the details. The business is clearly running on all cylinders with robust growth, margin expansion, and free cash generation.

I’ll keep this brief and point out a couple things that jumped out at me.

Levered Buyback?

In the past, CFO Spence Neuman has consistently poured cold water on the idea of levering up the balance sheet, always citing its lack of leverage as a valuable point of financial flexibility. Here he is on the 1Q 2024 call:

As I discussed in Netflix: A Change in Posture (April, 2024), it seemed like management first cracked opened the door to the idea of a levered buyback on their second-quarter 2024 shareholder letter with this language:

The word “currently” jumps off the page. Why is that word necessary? If levering up to buyback stock is simply not part of their philosophy and is unequivocally off the table, they don’t need the word “currently.” But there it is.

Around the same time, the language in the liquidity and capital resources section changed from

to

As you know, the language used in these filings is carefully considered by management and lawyers. Status quo is typical and changes to the language can give insights into potentially changing priorities or strategies.

M&A or buybacks are their only realistic choices for excess capital. But their culture is definitely a build over buy culture, so a major acquisition seems less likely. That said, the business is clearly evolving. The ad business is a growing priority. Live is a growing priority. Netflix is also knocking pretty hard on the door of sports with its Christmas Day NFL games and women’s World Cup deals. Perhaps acquiring and owning content they can run live and with ads could be on the table. Maybe a small sports league will be considered as this WSJ story from 2022 discussed. Given how easily Netflix massively accelerates viewership—Monday Night Raw just doubled its viewership in its first week on Netflix—there is a lot of potential value creation out there.

The question seems to be, “How much of the value creation Netflix will drive will be claimed by them through acquiring and owning content versus continuing to license content on advantageous terms (as I suspect they achieved with WWE and others)?” We’ll have to see, but I’ll assume more of the latter until proven otherwise.

That leaves buybacks, which have clearly been a priority lately. Netflix bought back $6.0 billion and $6.2 billion of stock in each of the last two years, respectively. And the board just increased its share buyback authorization by another $15 billion to a healthy $17.1 billion.

At year-end, Netflix had $9.6 billion of cash and short-term investments on hand, an untapped $3 billion revolver, and management guided to another $8 billion of free cash flow this year, assuming no major changes in foreign exchange rates. The total debt of $15.6 billion at year end is starting to look modest and underleveraged considering the company’s cash, cash generation, and trajectory. Are we going to see a big debt issuance this year that could facilitate them taking a big bite out of the $17.1 billion authorization?

First-Party Ad Stack

Netflix got into the ad business on the back of their Microsoft ad partnership, but has quickly developed the capabilities internally. They rolled it out in Canada in the third quarter and said this on the fourth-quarter call:

Netflix doesn’t explicitly disclose Canada revenue. But they do disclose UCAN revenue in their geographic segments and U.S. revenue (rounded to the nearest $100 million) elsewhere in their filings, so you can back into Canadian revenue. That math shows over the last four quarters Canada revenue growth appears to have been something like 5.1%, -1.3%, 37.1%, and 37.5% year-over-year, respectively. In comparison, U.S. revenue appears to have grown 18.2%, 21.2%, 14.3%, and 13.5% in the same quarters, respectively. While the U.S. revenue disclosure is rounded to the nearest $100 million and therefore allows for a range of U.S. and Canadian growth rates, regardless of what I assume for the rounding, there does seem to have been a pretty meaningful acceleration in Canada in the second half of the year. I don’t believe there was a price increase in Canada in the third-quarter that would explain that, especially given they are raising prices in Canada and elsewhere right now. So could we see a noticeable acceleration in the U.S. and elsewhere when Netflix rolls out its first-party ad stack to the U.S. and other markets in a few months? We’ll see.

Perhaps management knows this and intends to execute a levered buyback beforehand? Admittedly, I am layering a bit of speculation on top of more speculation.

Scenario Analysis and Valuation

Netflix beat my Base case paid membership numbers pretty handily last year. I’ve revised 2025 estimates upward to account for the recent trajectory although I assume a moderation from that pace. I’ve also accounted for management’s guidance on things like operating margin, content spending, and free cash flow. Essentially, over the long-term, my Base case paid memberships are up a bit, ARPU is up a little bit, operating margin is up a little bit, and free cash flow is up a bit. Big picture, I think I underestimated paid memberships from the ad-supported tier.

Here are the updated 20-year scenario analysis and corresponding DCFs that utilize the inputs from the scenario analysis.

Netflix Scenario Analysis 2025

4.9MB ∙ PDF file

Download

Download

Here is the valuation summary:

NFLX has now touched the low end of my updated valuation range. When I posted Netflix: A Valuation Update (June, 2024), the stock was trading at a 20% discount to the then-$800 per share low end valuation. That said, the whole range has moved up given the adjustments I discussed above.

While the stock doesn’t seem as undervalued as it once was—it was trading at a 61% discount to my Base case and below the whole range in June—I still think NFLX at a 30% discount to my Base case is an attractive investment.

Of course, the challenge of this work is whether the present fundamentals and what I learned from this quarter justifies the upward revisions I made to my long-term assumptions. Is the long-term paid membership count really likely to be a bit larger now than I previously thought? Or could it be the same, or even lower, and the business is just pulling forward that growth a bit faster than I thought? Pulling forward growth does add a bit of value but not as much as upwardly revising long-term estimates going forward.

What gives me some confidence that I’m not going crazy is my Base case still only has Netflix penetrating around 50% of broadband households outside UCAN. And that’s 20 years out. I’m still not sure what else half of those broadband households would prefer to watch over Netflix at that point. I’m assuming Netflix’s content budget might be something like $40 billion annually at that point—versus $18 billion this year—so the service is going to become even more content rich than it is now. And competitors will only continue to fall behind and focus on niche segments rather than Netflix’s all-things-to-all-people approach.

But obviously, the future is hard to predict with any precision. That’s why I build out a range of possible outcomes and corresponding valuations. At or below the low end is a fairly easy buy or hold for me, but investments become lower conviction for me as they creep higher into the range.

That’s what has happened with Spotify for me—see Spotify: Investor Fatigue to Exuberance Inside of Two Years (November, 2024). Although, I also recognize that my Spotify Premium ARPU growth has room to increase, which is a pretty powerful valuation driver. At some point, the bright future you expect becomes fully priced in, which implies the possibility of only average forward returns. Or maybe the future is not quite as bright as you expected, you simply overestimated value, and you end up with disappointing returns.

Disclosure: Long NFLX

Disclaimer: This post is for entertainment purposes only and is not a recommendation to buy or sell any security. Everything I write could be completely wrong and the stock I’m writing about could go to $0. Rely entirely on your own research and investment judgement.