This article was originally published on Forbes on Apr 25, 2020,11:30pm EDT

In October, many analysts predicted Netflix would be crippled by the launch of Apple Plus and Disney Plus. The new over-the-top services were called “Netflix-killers.” Around this time, I published a series of analysis on Netflix that discussed why competitive over-the-top applications would not be able to dethrone the original streaming media company even after Netflix had missed on subscriber numbers both domestically and globally.

Now that Netflix is up 32% while the broader market is down 13%, it’s important to discuss valuation and the longer-term prospects for this high-yielding growth stock.

Netflix is Unshakeable: Macro Overview

There are key reasons as to why Netflix is able to maintain its lead despite there being over 190 OTT providers in the United States. 

The main reason is that Netflix is a global media company whereas the majority of OTT providers are domestic. Netflix has over 60 million subscribers in the United States compared to 128 million households. Of the households that subscribe to OTT services, 87 percent have a Netflix subscription. 

At the time, I had stated that the market had been myopic with Netflix by overlooking broadband penetration rates and the lack of viable competitors on a global scale. For instance, outside of the United States, Netflix outperforms globally with 70-87% of subscription OTT video service users in European English-speaking countries using the service and 55-64% of non-English speaking countries. 

The global user data helps cut through the speculative noise as to whether Apple Plus or Disney Plus could dethrone Netflix. While many analysts were busy considering the domestic competition, they missed how little competition there is globally.

Asia-Pacific and India remain growth opportunities for Netflix, although pricing could be an issue due to high rates of piracy. For entry into China, Netflix secured a licensing deal with iQiyi, which is owned by Baidu. 

Netflix’s Covid-19 Opportunity:

Currently, filming has been halted globally. There is not much impact on new releases in the second quarter as the production is already complete, with the exception of dubbing options for certain titles. With the shutdown, movie studios like Paramount have sent theatrical releases to Netflix.

Netflix management has mentioned that since the company has a large library with thousands of titles for viewing, member satisfaction may be less impacted than with competitors, who have a shortage of new content. Some of the recent shows like the Tiger King, Love Is Blind, and Money Heist have been very popular.

The company did see some disruption in customer service. It has now hired 2,000 agents who are all working remotely. Customer service levels are now fully restored in spite of increased demand.

Using the Open Connect Technology the company was able to reduce network use by over 25 percent upon the request from a number of governments worldwide.

Challenges: Global Streaming Speeds

While traditional fundamental analysis would point towards debt and lack of free cash flow as the major risks for Netflix, I believe both will be greatly improved upon as broadband penetration rises globally. Broadband is slow to non-existent in many countries. For instance, Brazil reports a 20% annual improvement in households with 4 Mbps (megabits per second) or more. Netflix requires 3 Mpbs. Japan and South Korea have 50 million people with speeds of 100 Mbps or higher. 

Fiber technology and broadband are prominent in Japan and South Korea, along with Australia, Hong Kong, Malaysia, Singapore, Taiwan and Vietnam. There is room for growth once higher broadband rates are achieved in New Zealand, Indonesia, Thailand, India and the Philippines.

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Overall, OTT video is projected to grow to 6.4% of emerging market households, or 103 million, by the end of 2019. That is up from 19.4 million in 2014. By 2025, digital growth will add over 1 billion middle-tier consumers for telecom companies, which will help open up the market for OTT players.

Another challenge for Netflix will be growing subscribers after the lockdowns are lifted. As stated in the most recent earnings report, if a person didn’t join Netflix during the confinement, then the person is unlikely to join Netflix after the confinement. 

Current Valuation

Netflix currently trades at a PE ratio of 85. Despite being high relative to most stocks, Netflix’s PE ratio has a five-year average of 212. EV/EBIT is also low in terms of it’s five-year average. Meanwhile, forward price-to-sales is revisiting early 2019 levels at 7.5 and the current price-to-sales is higher than the five-year average at 9. 

As recent as January, Netflix was undervalued relative to its peers. The company had posted 0.17% returns — or nearly 0% — over the past 12 months, while Disney and Comcast were up 30% and 31%, respectively. 

Therefore, one could argue that Netflix was undervalued in January and more accurately valued now in terms of comparables with the 32% YTD gains from $323 to $426. 

Revenue increased 28% y-o-y to $5.77 billion. Net income more than doubled to $709 million from $344 million in the same period last year. Diluted EPS was $1.57 compared to $0.76 for the same period last year. The revenue beat analyst’s estimates by $22 million and EPS missed estimates by $0.07.

The company has added 15.8 million new paid memberships beating its own guidance of 7 million new users for the 1Q 2020. The total paid memberships at the end of the quarter were 182.86 million. However, the management is cautious for Q3 and Q4 as the growth in the first half may be a “pull forward” of the rest of the year. The management used the words guess and guesswork for the next quarter guidance, which it places at 7.5 million new memberships.

About the Debt Load … 

Clearly, Netflix has had to pay huge bills for becoming a global streaming service. The company spent $8.9 billion on content in 2017, $12 billion in 2018 and will pay a projected $15 billion in 2019.

Reed Hastings, one of the best entrepreneurial tech CEOs of the past decade, is clearly gunning for global territory. Naysayers may be right about high-risk debt becoming an albatross for the company, but the first-mover advantage that Netflix has secured is going to be hard to shake. In this way, the barriers to going global is protection from other competitors, albeit at a cost.

The company has cash and cash equivalents of $5.2 billion. Long-term debt was $14.2 billion at the end of the 1Q 2020. Netflix announced yesterday its plan to raise $1.0 billion in debt.

Interestingly enough, the criticism towards Netflix’s debt has now turned into a positive as the company has an arsenal of content at a time when many studios are closed for production. 

For the full-year 2020, due to paused productions, there will be a push in spend to next year. The management had previously estimated negative free cash flow of $2.5 billion and now it expects to be around negative $1.0 billion. Despite the “lumpiness” in free cash flow, management still believes 2019 will be the peak in annual FCF deficit. 

Conclusion:

I believe Netflix’s addressable market stands at 50-70% of the developed world and 20% of the developing world based off of 1.6 billion television households worldwide. This puts the blended rate at 35%, or 560 million on the low end and 720 million on the high end. In order to achieve this number, broadband penetration must become a tailwind rather than a headwind in the regions where growth opportunities remain.  

Covid-19 is an unfortunate circumstance that has revealed which technologies are essential. Gene Munster, an analyst at Loup Ventures, told CNBC that “Netflix is not going to make a dramatic change to our lives in the next decade.” He missed the point entirely that Netflix made this dramatic change in the United States and is set to make an even more dramatic change for the remaining 6.5 billion people globally.