978-0073526898 Case Netflix Part 3

subject Type Homework Help
subject Pages 7
subject Words 665
subject Authors Richard Sloan, Russell Lundholm

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Valuation Analysis (13)
The default valuation is -$49.44/share.
The negative valuation arises because the default assumptions
imply a terminal ROE of 3.6%, much lower than the cost of capital
of 10%.
lower than cost of capital), a negative value is generated.
Note that the main cause of the negative valuation is the
depreciation assumption. As growth slows, the depreciation rate
will fall (since it is expressed as a % of average net PP&E balance
and Netflix is using accelerated depreciation)
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Valuation Analysis (14)
The following slide provides a set of forecasting
assumptions generating a valuation of $12.07/share.
Starting point is the 2005 and 2006 forecasts used in
the solution to Q. 10.
Depreciation rate is trended to 272% terminal rate.
Note that this amount is reasonable, as rate is
expressed as a % of net PP&E, and accelerated sum-
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Valuation Analysis (14)
Forecast Horizon TERMINAL
Estimated Price/Share=$12.07 YEAR
Forecast Forecast Forecast Forecast Forecast Forecast
Fiscal Year End Date 12/31/2005 12/31/2006 12/31/2007 12/31/2008 12/31/2009 12/31/2010
Implied Return on Equity 0.102 0.254 0.229 0.200 0.171 0.142
Income Statement Assumptions
Sales Growth 36.4% 44.2% 34.4% 24.6% 14.8% 5.0%
Cost of Goods Sold/Sales 42.2% 46.2% 46.2% 46.2% 46.2% 46.2%
R&D/Sales 4.4% 3.9% 3.9% 3.9% 3.9% 3.9%
Non-Operating Income/Sales 0.5% 0.5% 0.5% 0.5% 0.5% 0.5%
Effective Tax Rate 0.0% 0.0% 8.8% 17.5% 26.3% 35.0%
Minority Interest/After Tax Income 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Other Income/Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Ext. Items & Disc. Ops./Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
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Valuation Analysis (14)
Overall evaluation of forecasting assumptions
These forecasts assume that Netflix can earn a
short-run ROE of 25% and a long-run ROE of 14%
relative to its cost of capital of 10%.
These forecasts are very aggressive, particularly
since competition is strong and DVD by mail is likely
to be an largely obsolete technology by 2010.
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Valuation Analysis (15)
It seems likely that 2006 will be Netflix ‘peak’
earnings year, after which time downloading of
rental movies will pressure Netflix’ profitability, so
30 multiple on 2006 earnings is aggressive.
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Wall Street Journal, September 6, 2006
Apple, Amazon to Unveil Movie Downloads
Much-Anticipated Services
Movies on the small screen are about to receive a big boost as two high-profile
companies -- Apple Computer Inc. and Amazon.com Inc. -- lift the curtain in the coming
days on new movie-downloading services.
The services from the two companies are among the most widely anticipated efforts yet
to get consumers to buy or rent videos over the Internet rather than trudging to the local
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Key Takeaways
Firms in the same industry can employ very different
business models that have very different financial
characteristics
questionable

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