Barclays on Monday took a new swing at the difficult task of valuing growth companies, applying its new framework to the often opaque valuation of Netflix.
"Overall, our methodology does suggest that if Netflix's present business model is held constant, the stock is very expensive relative to its TAM," Barclays analyst Kannan Venkateshwar wrote, referring to total addressable market.
Under the new framework, Barclays found that Netflix's current valuation can only be justified if the company increases its revenue per user while decreasing its rate of customer turnover, Venkateshwar said.
Barclays estimates Netflix would need to grow its subscriber base several times over to justify its current valuation.
The firm found that Netflix' current valuation includes having 750 million to 1.3 billion subscribers by the time it reaches its "end state" in 2026, when it is predicted to stop growing. Even at the low end of the range, that's more than Netflix's total addressable market of about 700 million subscribers, Barclays found.
"In other words, Netflix's base of subscribers will have to go up at least [five to eight times] from where it is today in order to justify its present valuation, which will need growth to accelerate rather than slow," Venkateshwar said.
Netflix shares fell 1.8% Monday to close at $265.92. Barclays has an overweight rating on the stock with a $375 price target.
The stock was one of Barclays' picks to analyze with this new framework. It cited Netflix as one of the fastest-growing in media that simultaneously is one of the trickiest companies to value. Additionally, Netflix market share is still only beginning to grow internationally, where Venkateshwar says investors expect the company to get many more subscribers.
But he said Netflix can't reach beyond its total addressable market, so it will have to find significant other sources of revenue, such as advertising. In that case, the company's present valuation represents the pricing power strength it has over competitors and the decline in subscriber turnover, otherwise known as "churn."
Venkateshwar said Barclays developed its new framework because "traditional valuation frameworks have become insufficient in a growing number of instances."
The alternative the firm presents is "the ratio of enterprise value to adjusted/fully loaded lifetime value," Venkateshwar said. Essentially, Barclays takes the enterprise value of a company and divides it by its customer life time value. Customer life time value is the current value of a company's gross margins earned over the life of a customer.
"We provide an alternative framework to approach the valuation of the subscription businesses, and we believe that, with some modification it can be applied across multiple industries and sectors," Venkateshwar said.
Barclays noted that "isn't without its own limitations" but "helps provide a more tangible valuation framework for growth companies than the simple revenue multiple that is commonly used today." Beyond Netflix, the firm also tested its framework on the valuations of Verizon, Sirius XM Radio and The New York Times.