The stock of Netflix is very expensive when compared to its peers.

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1 Don't Buy Netflix, At Least Not Now Mar. 11, :32 PM ET Summary The stock of Netflix is very expensive when compared to its peers. The firm's capital structure is unsustainable. The existing model may not work in the near future. My target price for the stock is $280 (11.6% downside). Shorting directly is very risky as momentum is still strong, investors should take advantage of put option to profit from the initial drop. Netflix(NASDAQ: NFLX) first caught my attention as a potential short opportunity during the early February selloff, after running up from $196 to $286 (30% rise within a single month!), the stock not only did not lose its momentum but rebounded strongly and broke its 52- weeks high merely 10 days after the selloff. This bewildered me as the firm has the weakest balance sheet within FAANG stocks. After looking into the details of financials of the firm, not only is the valuation exorbitantly high but the capital structure of the firm is by no means sustainable. Its stock price is merely driven by investor's fear of missing out rather than sound development s of the firm's fundamentals and investors should not purchase the stock at current price.

2 Unsustainable capital structure

3 Netflix s capital structure is very unhealthy. Share price is not the only thing of the firm that has skyrocketed, the amount of debt accumulated on the company s balance sheet also rose astronomically over the years as the firm is investing a substantial amount of cash to produce exclusive content in order to remain the leader of the increasingly competitive streaming market. In other words, the continuous cash burning is a part of the company s usual operation cycle instead of an upfront investment that will eventually cease and generate income for the firm. Cash used for addition to content library increased from $2515 million in 2012 to $9805 million in 2017 and this number is almost certain to rise in 2018 as competition is rising within the industry,

4 Netflix s investment on media content will only increase as time goes by. Making matter worse, the diversity and quality of content are Netflix s moat, unlike Google and Facebook, Netflix does not enjoy network effect through which users join because those around them are using the same service. To maintain its competitiveness, Netflix has to continuously spend lavishly to add content to its platform. (Company Filings) We have established that a consistent cash flow is essential to Netflix s success, now let s take a look how Netflix generates its cash. In 2017, Netflix generated almost all of its cash from financing activities, of which $3.02 billion from the issuance of debt and $88.3 million from issuing common stock. (Add cf statement) By the end of 2017, the firm has $2.82 billion of cash in hand. Assuming Netflix continues to burn $450 million USD of

5 cash each quarter on operating-related activity, the firm can only support itself for 6 quarters before needing another capital injection. Netflix is rated as B+ by the S&P and B1 by Moody s. The bond issued last year was issued at 4.975% or 256 bp above equivalent treasury yield. As yield is currently normalizing, it is very unlikely for Netflix to obtain such amount of loan with such low-interest rate unless the firm improves its balance sheet significantly. In addition to that, Netflix s debt will start to mature in 2021, at current pace, the company has little chance to generate positive cash flow to pay for its debt.

6 (Company Filings)

7 Valuation Expensive valuation comparing to peers. (Data compiled from Yahoo Finance) From the comparative analysis, it is apparent Mr. Market is giving Netflix generous valuations. Netflix's market cap is 1.8x that of Fox while only generating 41% of Fox s revenue. Netflix s market cap is approaching that of Disney, a 94-year-old company with the rights of legendary franchises such as Star Wars and Marvel heroes. Not only is Netflix has the highest EV/EBITDA value but it also has the highest Price-to-revenue ratio. There s no doubt that Netflix s stock is overvalued at the current price, so how much is the stock really worth? As the stock does not has any close competitors, I will be evaluating it using Price to revenue ratio and EV/EBITDA ratio.

8 The price to revenue method shows Netflix s stock is only worth 2/3 of its current value. In the analysis, I have used the closing price of the last day of trading of each year. Taking the average of the past 5 years, I expect Netflix s stock to end 2018 with a Price to revenue ratio of 5.83, multiplying that with the expected revenue per share, we get $ per share. The EV/EBITDA analysis also reveals similar result as the P/R ratio analysis did. Netflix currently has an EV/EBITDA ratio of , which is exceptionally high when compared to other revolutionary internet giants (AMZN: 50.57, GOOG: 18.83, FB: 21.18). Such high valuation is by no means sustainable, so we are expecting the ratio to drop in Giving the stock a 60x EV/EBITDA ratio (Still significantly higher than its peers) and an EBITDA of $1.932 billion, we calculated the fair value of the stock to be $224.9 per share. Even if the ratio only drops to 80, the fair price per share is still below the current trading price. In addition, in this analysis, I have assumed the number of shares to remain constant, which is very unlikely. Combining the results from both analysis and giving 50%

9 weighting to each of the results, I believe Netflix s stock is worth $215.3 per share, applying 30% margin of safety to my calculation, I am giving the stock a target price of $280 ( 11.6% downside) and rate the stock as a sell. I recommend investors who are holding the stock to start taking profit while who don't refrain from buying and consider the action below. Action (Tradingview) Now is not the moment to short the stock. After breaking through previous resistance in January, Netflix's stock price is going all the way North and it is not showing any signs of stopping yet. The momentum of the stock is too strong to short, therefore, I recommend investors to

10 purchase (previous minor resistance) Put option that expires in a year to take advantage of the initial drop and wait for the stock's momentum to weaken before entering the short position. Conclusion There s no doubt that Netflix is still rapidly growing, however, growth alone cannot justify its current valuation. The firm is not only consistently burning large sum of cash to maintain its competitive advantage, but also have failed to find a sustainable capital structure. When liquidity in the market decreases, the firm is going to face a dire financial situation and by then it may be too late to get out.