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Analysts question Netflix valuation as 'Squid Game' drives stock

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Analysts question Netflix valuation as 'Squid Game' drives stock

Content is king, and Netflix Inc. is still the seat of the empire.

The company reported a membership beat in the third quarter and offered fourth-quarter guidance almost twice the third-quarter result. The streaming platform has a massive content slate planned for the fourth quarter, with its current crown jewel "Squid Game," a widely popular dystopian series out of Korea, already driving viewership and platform adoption.

The quality of Netflix's content, coupled with its global reach, will continue to attract both subscribers and creators and protect the company from the mounting competition, executives argued on the Oct. 19 earnings interview.

Some analysts agree with the executives, with Pivotal Research Group's Jeffrey Wlodarczak saying Netflix operates in a virtuous cycle.

"The larger their subscriber base grows (and their ARPU increases) the more they can spend on original content, which increases the potential target market for their service (and reduces existing subscriber churn) + enhances their ability to take future price increases and dramatically increases barriers to entry," he said in a note.

Others, though, remain suspicious of the company's expensive valuation, noting it will be years before Netflix's growth efforts, like gaming and its ambitious cross-marketing plans, impact earnings and valuation.

The price is right?

Netflix has a competitive "moat" around its platform when it comes to global reach, content spending, and recommendation and discovery technology, said MoffettNathanson Research analyst Michael Nathanson in a note following the earnings report, but "we don't think it is as deep a moat as Google [LLC]'s search business, Amazon.com Inc.'s delivery and logistical prowess or the ecosystems of Apple Inc. or Microsoft Corp."

For that reason, Nathanson said he was unable to justify paying 24x estimated 2025 EPS for the streamer when he could pay 18x to 23x for Facebook Inc. or Alphabet Inc. The analyst maintained his "neutral" rating on the company and added just $5 to his $465 price target.

Nathanson also found the company's guidance of 8.5 million paid net additions disappointing, even though it would represent the biggest quarterly guidance figure in over two years.

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"Despite the record 'Squid Game' viewership and worldwide interest, the 4Q sub guide of +8.5 million global net paid adds is below our +9.8 million prior estimate," Nathanson said. "Given the in-line subscriber guidance and margins likely slowing into next year, we don't think the upside from Squid Game warrants the recent run in the stock."

Indeed, Netflix stock was on a tear leading into its third-quarter earnings release. Shares closed Oct. 19 at $639.00, up 20.0% from its July 20 second-quarter earnings announcement, compared to just 6.5% for the S&P 500.

As of midday on Oct. 21, the stock was trading above $645.

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Positive free cash flow

Netflix's strong subscriber growth during the pandemic has supported a turn from a cash-burn company to a break-even company, and executives reiterated their guidance for positive free cash flow in the fourth quarter.

The turn to profitability, despite its position as one of the biggest content spenders in the video business, has supported some bullishness among analysts. Netflix's net content assets totaled $28.97 billion in the third quarter.

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"We remain constructive given the strong content path, nascent gaming narrative and buybacks," Truist Securities analyst Matthew Thornton said in a note following the company's earnings.

Thornton reiterated his "buy" rating on the company and $690 price target. The company's fourth-quarter and 2022 content slate, which includes new seasons from popular series like "Witcher" and "Stranger Things," will continue to support strong earnings and membership growth as well as strong investor interest, he said.