Discussion Materials December 10, 2012
Assumptions The following analysis estimates the break even U.S. streaming subscriber growth or price increases required in order for Netflix to pay $300 to $350 million(1) in incremental programming spend for the deal in 2016 and 2017, and $575 to $650 million for and Sony deals combined in 2017 Our break even analysis assumes zero gross profit from Netflix s Domestic DVD and International Streaming businesses (Revenue = Programming Spend for these businesses) Over the last 12 months, Domestic DVD generated $1.3bn in revenue and $604mm of contribution profit; however, these amounts are projected to decline over time Over the last 12 months, International Streaming generated $215mm of revenue and a contribution profit (loss) of ($344mm) Total projected company marketing, technology and G&A expenses are assumed to be fully absorbed by the U.S. streaming business (including costs that could be attributed to Domestic DVD or International Streaming, such as international marketing) If Domestic DVD and International Streaming businesses have positive gross margins, this would positive contribute to Netflix EBIT (1) Estimate based on public research to date
Conclusions ($ and subs in millions, except for $ per sub) Netflix will need to continue to either grow faster than US Broadband households due to Word of Mouth, more/better/exclusive content available, better user experience etc. or increase its monthly price per subscriber, or some combination of both. SPE s preliminary view is in agreement with equity research analysts that Netflix will need to pull a combination of levers in order to meet its content payment obligations. The growth assumptions do not appear out-of-reach but carry a significant risk Per the analysis below, at $7.99, paid US subs need to grow at a CAGR of 12.4% from $25.1mm for 2012E to 45.0mm in. This would imply an increase in U.S. Broadband Households penetration from 28.6% in 2012E to 42.5% in Sensitivity: Break Even Analyses at $7.99 Constant Price and Varying Subs Growth Incremental EBIT Required to Break Even 2013E - Sub Growth & SPE s & SPE s Incremental Subs Required to Break Even 2013E - Sub Growth (1,391) 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 0% 2.0% 4.0% 6.0% 8.0% 10.0% $300.0 ($1,611.3) ($1,361.3) ($1,090.9) ($798.8) ($483.8) ($144.7) $300.0 16.8 14.2 11.4 8.3 5.0 1.5 $325.0 ($1,636.3) ($1,386.3) ($1,115.9) ($823.8) ($508.8) ($169.7) $325.0 17.1 14.5 11.6 8.6 5.3 1.8 $350.0 ($1,661.3) ($1,411.3) ($1,140.9) ($848.8) ($533.8) ($194.7) $350.0 17.3 14.7 11.9 8.9 5.6 2.0 $575.0 ($1,886.3) ($1,636.3) ($1,365.9) ($1,073.8) ($758.8) ($419.7) $575.0 19.7 17.1 14.2 11.2 7.9 4.4 $600.0 ($1,911.3) ($1,661.3) ($1,390.9) ($1,098.8) ($783.8) ($444.7) $600.0 19.9 17.3 14.5 11.5 8.2 4.6 $625.0 ($1,936.3) ($1,686.3) ($1,415.9) ($1,123.8) ($808.8) ($469.7) $625.0 20.2 17.6 14.8 11.7 8.4 4.9 $650.0 ($1,961.3) ($1,711.3) ($1,440.9) ($1,148.8) ($833.8) ($494.7) $650.0 20.5 17.8 15.0 12.0 8.7 5.2 Additional Subs vs. Today (25.1mm subs) of Total Subs to Break Even Household Penetration Subs Subs Subs Subs $300.0 16.8 $300.0 41.9 $300.0 10.8% $300.0 39.6% $325.0 17.1 $325.0 42.1 $325.0 10.9% $325.0 39.8% $350.0 17.3 $350.0 42.4 $350.0 11.1% $350.0 40.0% $575.0 19.7 $575.0 44.7 $575.0 12.3% $575.0 42.3% $600.0 19.9 $600.0 45.0 $600.0 12.4% $600.0 42.5% $625.0 20.2 $625.0 45.3 $625.0 12.5% $625.0 42.8% & SPE s Total Subs $650.0 20.5 $650.0 45.5 $650.0 12.7% $650.0 43.0% Per the analysis below, if subs remain flat at 25.1mm over the projection period, price points of $12.57 per US sub per month in 2016E and $14.35 in would be needed to break even If subs grow at 4.0% CAGR in line with analyst projections for increases in U.S. broadband households, a price point of $11.79 in would be needed to break even & SPE s & SPE s & SPE s 2012E- Expected CAGR & SPE s Broadband Incremental (over $7.99) Monthly Fee per Sub Required to Break Even Total Monthly Fee per Sub Required to Break Even 2013E - Sub Growth 2013E - Sub Growth 0% 2.0% 4.0% 6.0% 8.0% 10.0% 0 0% 2.0% 4.0% 6.0% 8.0% 10.0% $300.0 $5.36 $4.10 $2.98 $1.99 $1.10 $0.30 $300.0 $13.35 $12.09 $10.97 $9.98 $9.09 $8.29 $325.0 $5.44 $4.18 $3.05 $2.05 $1.15 $0.35 $325.0 $13.43 $12.17 $11.04 $10.04 $9.14 $8.34 $350.0 $5.53 $4.25 $3.12 $2.11 $1.21 $0.40 $350.0 $13.52 $12.24 $11.11 $10.10 $9.20 $8.39 $575.0 $6.27 $4.93 $3.73 $2.67 $1.72 $0.87 $575.0 $14.26 $12.92 $11.72 $10.66 $9.71 $8.86 $600.0 $6.36 $5.00 $3.80 $2.73 $1.77 $0.92 $600.0 $14.35 $12.99 $11.79 $10.72 $9.76 $8.91 $625.0 $6.44 $5.08 $3.87 $2.79 $1.83 $0.97 $625.0 $14.43 $13.07 $11.86 $10.78 $9.82 $8.96 & SPE s $650.0 $6.52 $5.16 $3.94 $2.86 $1.89 $1.02 $650.0 $14.51 $13.15 $11.93 $10.85 $9.88 $9.01
Other Considerations Risks: 1) further increasing content costs, 2) potential new competitors in the company's streaming business, 3) execution challenges and competition potentially limiting growth in new markets, 4) the possibility of ISPs to look to recoup higher rents for Netflix's high bandwidth requirements for streaming, 5) subscriber price inelasticity risk if price hike is to take place, 6) higher than expected churn Opportunities: 1) content costs rising slower than expected, 2) total subscriber growth is faster than expected, 3) Netflix repairs public image and regains lost customer loyalty, 4) Netflix gets acquired, 5) Netflix develops successful original content and establishes itself as a head-to-head competitor of traditional PayTV networks (5 originals expected to be released in 2013), 6) Netflix has churned off subs of ~17mm in FYE 2011 and is expected to have churn off subs of ~19mm by 4Q13. If these subs are added to the current US subs of 25.1mm, Netflix would have or have already gone through ~ 50% of total US broadband households, a possible but unlikely penetration scenario Additional Financing: It is unlikely that Netflix will be able to raise a substantial amount of debt or equity in 2017 to finance programming spend given its on and off balance sheet liabilities and assuming similar to the current capital structure If we assume 4% annual subscriber growth and $600mm of additional combined programming spend in 2017 for the Sony and deals, the additional EBIT required to break even of $1.4bn would imply an equity dilution of 22.6%(1) if shortage financed through new equity, a very unlikely scenario Netflix has limited capacity to raise additional debt. Although the company has only $400mm of debt (2.7x Debt/EBITDA), it has significant on and off balance sheet liabilities. Netflix has (i) $4bn of on balance sheet content liabilities and an additional $5bn of off balance sheet liabilities (commitments to studios). As studios will need to get paid prior to debtholders and shareholders in the event of default/liquidation, the $9bn of priority studio commitments makes a significant new debt offering unlikely (1) Based on $4.8bn current market capitalization
Appendix
Netflix U.S. Streaming Historical & Projected Financials Historical Wall Street Research and SPE Projections 2009 2010 2011 2012E 2013E 2014E 2015E 2016E Beginning N etflix Streaming Subscribers (US & Paid) 11.9 17.9 22.9 25.1 26.1 27.1 28.2 29.3 Plus: Incremental Subs 6.0 4.9 2.2 1.0 1.0 1.1 1.1 1.2 Ending N etflix Streaming Subscribers (US & Paid) 11.9 17.9 22.9 25.1 26.1 27.1 28.2 29.3 30.5 Growth % 29.8% 50.8% 27.4% 9.6% 4.0% 4.0% 4.0% 4.0% 4.0% Implied Penetration of N etflix Subs / Broadband Households 16.6% 23.8% 27.5% 28.6% 28.5% 28.4% 28.4% 28.6% 28.8% Cumulative Incremental Subs 1.0 2.0 3.1 4.3 5.4 Subscriber Cost per Month $7.99 $7.99 $7.99 $7.99 $7.99 $7.99 Incremental Revenue from Incremental Subs $96.1 $99.9 $103.9 $108.1 $112.4 Cumulative Incremental Revenue $96.1 $196.0 $300.0 $408.1 $520.5 Total Revenue US Streaming Revenue $2,402 $2,498 $2,598 $2,702 $2,810 $2,923 Cost of Revenues $1,492 $1,738 $1,883 $2,039 $2,209 $2,392 Incremental Cost of Revenue- $325 $325 Incremental Cost of Revenue-Sony $275 Total Cost of Revenue $1,492 $1,738 $1,883 $2,039 $2,534 $2,992 Gross Profit $911 $760 $716 $663 $277 ($69) Gross Margin 37.9% 30.4% 27.5% 24.5% 9.9% -2.4% Marketing Expense $505 $545 $560 $576 $592 $609 Technology $334 $363 $397 $433 $473 $517 G&A $122 $139 $151 $165 $180 $196 EBIT - Excluding DVD Business and Intl ($50) ($286) ($392) ($511) ($968) ($1,391) Break Even Analysis Break Even Based on Growing Subs Additional US Paid Subs Needed to Break-Even @ $7.99 0.5 3.0 4.1 5.3 10.1 14.5 Total Subs for break even 25.6 29.0 31.2 33.5 39.4 45.0 Implied Penetration of N etflix Subs / Broadband Households 29.2% 31.7% 32.6% 33.8% 38.4% 42.51% Additional Subs vs. Today (25.1mm) 4.0 6.1 8.5 14.4 19.9 Expected CA GR to break even 15.9% 11.6% 10.2% 12.0% 12.4% Break Even Based on Growing Monthly Sub Fee Current Subs Growth: 4.0% 25.1 26.1 27.1 28.2 29.3 30.5 Amount of EBIT Needed to break even ($MM) $50.1 $286.0 $392.0 $510.6 $968.1 $1,390.9 Implied Incremental Monthly Fee per Sub Needed $0.17 $0.91 $1.21 $1.51 $2.75 $3.80 Current Monthly Fee per Sub $7.99 $7.99 $7.99 $7.99 $7.99 $7.99 Per Sub Monthly Fee Required to Break Even $8.16 $8.90 $9.20 $9.50 $10.74 $11.79
U.S. Broadband Households Forecast Historical Third Party Research Projections 2009 2010 2011 2012E 2013E 2014E 2015E 2016E Total Households (US) 115.1 116.0 116.5 117.9 119.4 120.5 121.6 122.5 123.4 Growth % 1.1% 0.7% 0.5% 1.1% 1.3% 0.9% 0.9% 0.8% 0.8% Internet Households (US) 93.5 93.2 94.4 94.7 94.7 97.2 99.8 103.5 107.3 Growth % 2.1% (0.3%) 1.3% 0.3% 0.1% 2.6% 2.7% 3.7% 3.7% Broadband Households (US) SNL 86.1 89.9 93.4 96.5 99.5 102.3 105.0 PWC 71.5 75.2 80.4 85.2 89.7 94.7 98.8 103.0 106.6 Average Broadband Households (US) 71.5 75.2 83.2 87.5 91.6 95.6 99.2 102.7 105.8 Growth % 5.8% 5.2% 10.6% 5.2% 4.6% 4.4% 3.7% 3.5% 3.1% Broadband Household Penetration / Total Households 62.1% 64.9% 71.4% 74.2% 76.7% 79.3% 81.6% 83.8% 85.8%
PayTV Landscape Pay TV Channel # of Subs (mm) (2012) Total HH Penetration (2012) Revenue ($ bn) (2012E) Monthly Revenue per Sub HBO 28.6 24.3% $3.1 $9.14 Cinemax 12.0 10.2% $1.3 $9.14 Showtime 21.9 18.6% $0.5 $1.77 TMC 21.8 18.5% $0.5 $1.77 Flix 32.0 27.2% $0.7 $1.77 Starz 20.8 17.7% $0.5 $2.03 Encore 34.3 29.1% $0.8 $2.03 Epix 5.6 4.7% $0.4 $6.65 Netflix 25.1 21.3% $2.4 $7.99 Netflix (2017) 45.0 36.5% $4.3 $7.99 Source: SNL Kagan and Netflix breakeven analysis for Netflix (2017) data Revenue for Starz/Encore and for Showtime/TMC/Flix provided in total and allocated to the specific network based on the number of subscribers.