To see if this drop will finally allow me to average down I updated my valuation, using the intrinsic value model Pabrai writes about in Mosiac.
Current Excess Capital On Hand $1,749.0
Starting FCF $1,094.50
Next Year Growth 12%
Year 2 - 4 10%
Year 5 - 7 10%
Year 8 - 10 8%
Discount Rate 9%
Shares Outstanding in Year 1 768.00
Shares Compound Rate -0.50%
PV 10 Year Sale, Years 1-10 FCF,
and Excess Capital 24,895.99
Year 10 Shares Outstanding 730.45
Price/Share $34.08
Price/Share w/50% margin of safety $17.04
Year FCF PV of FCF
Start $1,094.50 $1,094.50
1 1,225.84 1,124.62
2 1,348.42 1,134.94
3 1,483.27 1,145.35
4 1,631.59 1,155.86
5 1,794.75 1,166.47
6 1,974.23 1,177.17
7 2,171.65 1,187.97
8 2,345.38 1,177.07
9 2,533.01 1,166.27
10 2,735.65 1,155.57
sale 27,356.54 11,555.70
fcf 19,243.80 11,591.29
Total 46,600.34 23,146.99
In this DCF I use assumptions of 12% growth next year,
then 10% every year before years 8-10 when I predict 8% growth.
I also assume Western Union will buy back .5% of its shares every year.
This puts the value at 34.08, not the 50% discount that Pabrai looks for but 40% discounted which is enough for me in a business I like and I've bought more today.
Netflix
Munger said checklists should be used in investing which is why once again I'm using Buffett's checklist according to Hagstrom to look at Netflix.
Business
Simple, Understandable
Yup. They are an online movie rental business. They have over 75,000 titles available to rent online and multiple different paying options depending on how many movies one would like to rent at once. They also have started with digital downloads of movies that customers can watch in their web browser.
Consistent History
Um, younger than me so not really long. But it is consistent.
Favorable Long-Term Prospects
Excuse my French, but Hell Yes! Uncertainty on this is what is depressing the price, but they did so well fending off Wal-Mart that Amazon.com decided to can its business renting DVDs. People also think Blockbuster will kill Netflix but so far its spent hundreds of millions of dollars on its Online Rental business only to get it not as good as Netflix and to have less then a third of the share of Netflix, still. Right now it is basically giving away movies Blockbuster will probably have to choose online or stores pretty soon, if not it will have to raise its price on Total Access which will allow Netflix to gain a lot of Blockbuster's subscribers.
Management
Rational
Yes. Netflix knows exactly what it's doing and what will happen to its business in the future.
Candid
They have the best IR Site I've seen. Even including Videos with the executives discussing the business.
Resist Institutional Imperative
Management appears to be more focused on finding shareholders for the long haul and not on short term results.
Financial
Return on Equity
Currently Netflix has an OK ROE of 16%, I believe in the future as its marketing expenses dip relative to revenue ROE will rise to a very god number reflecting its dominance in the industry.
Owner's Earnings
Income 49,082
+ D&A 88,204
- CapEx 15,720
=Owner's Earnings - $121,566
Profit Margins
Currently Owner's Earnings Margins are at 24%, very high and it will only rise in the future as marketing and technology expenses fall.
Value
Using the same method I used for WU with growth next year of 20%, and then growth of 18% until year 8 when it reduces to 10% and a discount rate of 12% I get a value of $48 per share, which is way above the current price, but also just a starting point.
Conclusion
The valuation model I used was set-up to be aggressive, because Mohnish was using it to show how overvalued some tech stocks were, which is why I used such conservative inputs with WU, but I also believe my Owner's Earnings estimates for Netflix may be high, I will continue looking at it, I definitely believe it is a value stock flying under the radar.
8 comments:
Mike,
On your Netflix FCF calculation: video rental companies must build their rental library (their primary capital expenditure) as they grow. So after adding back D&A for 2006, you must subtract "Acquisitions of DVD Library" which amounted to about $100mm for 2006.
But for NFLX - if you are looking at future capital requirements you really need to also look at Working Capital. Since they receive monthly subscription fees ahead of time, they have a "float" on their balance sheet, and hence their negative Working Capital is really what is funding their growth, not FCF (look at Operating Cash Flow). This makes Return on Invested Capital almost negative, but probably around 400-500% for 2006.
~Max
I think Netflix is cheap to. I wrote a piece on my blog about them. My only problem and a big longterm one is how the industry will change to video on demand directly into homes. The internet and tv tech evolve fast. I bought Movie Gallery MOVI when they were doing great and they had way better financials than blockbuster, now their history. The industry will be different again in few years.
http://treasurehuntingquest.blogspot.com/2007/04/netflix-nflx-undervalued.html
Mike,
I thought your analysis was good on Western Union. One thing to point out regarding the shares outstanding assumptions. The weighted average basic/diluted shares as reported in the income statement is misleading. This was actually a reason why I sold that stock recently. If you take a look in the footnotes of the 10-Q/10-K, you will see there are 73MM diluted shares in employee stock options (70.4MM) and restricted stock units (2.5MM). If you strictly look at the income statement (as I once did), you will see a 15MM share difference between basic and dilutive. But really there are approx 60MM more.
How about a value player that can realistically give you 2000% return (x20 folds) in 4 years, based on reasonable P/E of only 10, and the fact that palladium metal price doubled in past 2 years, and should double again in another two years.
http://stockology.blogspot.com/2007/06/swc-is-next-apple-20-folds-in-4-years.html
Do your own DD.
Just curious,how do you see Netflix growing at 18%? Lately, they have been getting the pooh kicked out of them by Blockbuster and seem to have no answer to Blockbuster using their brick and mortar operations. In addition, new competition is popping out everywhere.
How can you possibly attempt to predict the future of WU's free cash flow when you only have two historical years to look at? It looks like you are using two years of historical data and an arbitrary growth rate (with no relative business basis for WU) to project ten years into the future. It doesn't make any sense.
Take a look at this evaluation of Buffett's purchase of JNJ. From a business value perspective, JNJ is worth buying. I can't imagine that Pabrai would agree with making unfounded assumptions on a company's future cash flow simply because the company is old.
Just browsing the internet, very, very interesting blog.
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