1. Team: 9th November, 2018 Daniel Gonzalez de Heredia Indrė Jančiūtė
Brigita Lapinskienė
Irina Morozova
Evelina Butkutė
9th November, 2018

2. Company background (1)
Founded in 1997 by Reed Hastings as an internet based unlimited rental service for digital videos (DVD format).
Service area in the United States.
Better image and sound quality in the content.
Innovative system to select and rent movies.
Sending DVD-s to subscriber by mail.
Biggest competitors were video clubs such as “Blockbuster video”, “Hollywood Video”, etc.

3. Company background (2)
In April 2000 Netflix had submitted filling for its first initial public offering (IPO). In order to have a successful offering and to meet the requirements, they had to show positive cash flow within 12 month horizon. They should decide whether to proceed with IPO.
NetFlix had long-run objectives: growth and increased market share in a billion dollar market. NetFlix wanted to convert as many free trial users to paid users as possible and over the long run to maintain paid users. By those means they wanted to achieve their long-run objectives.
NetFlix considered whether they could afford to continue offering a free month of service in order to attract potential new subscribers and at the same time whether the company could afford not to do so.

4. First years evolution
Launch of the website in April 1998  Revenues grew from 1,4M dollars in 1998 to 5M dollars in 1999
Growth between the employees:
Losses between :
Year
1998
1999
Revenues
$ 1,4
$ 5,0
Growth *
357,14 %
Year
1998
1999
Employees 46
270
Growth *
587 %
Year
1998
1999
Losses
$ 11,1
$ 29,8
Growth *
268,47 %

5. Questions What could be said about NetFlix financial health?
What is the value of a new subscriber? What are expected cash flows of new subscribers for next five years?
Can Netflix afford to continue offering a free month of service to attract potential new subscribers
Is Netflix ready for Initial public offering?

6. Income statement 1998-1999 Revenues $ 1 339 $ 5 006 Cost of revenue$ $
Cost of revenue $ $
Gross profit $ $
Operating expenses:
Product development $ $
Sales and marketing $ $
General and administrative $ $
Stock-based compensation $ $
Total operating expenses $ $
Operating income (loss) $ $
Other income (expense):
Interest and other income, net $ $
Interest expense, net $ $
Net income (loss) $ $

7. Balance sheet 1998-1999 Assets Current assests
Cash and cash equivalents $ $
Short-term investments - $
Prepaids and other current assets $ $
Total current assets $ $
Rental library, net $ $
Property and equipment, net $ $
Deposits and other assets $ $
Total assets $ $

8. Balance sheet 1998-1999 Liabilities and Shareholders' Equity
Current liabilities:
Notes payable $ $
Current portion of capital lease obligations $ $
Accounts payable $ $
Accrued liabilities $ $
Deferred revenue $ $
Total current liabilities $ $
Capital lease obligations $ $
Note payable $
Total liabilities $ $
Mandatorily redeemable conv. pref stock $ $
Shareholders equity (deficit):
Convertible preferred stock $ $
Common stock $ $
Additional paid-in capital $ $
Deferred stock-based compensation $ $
Accumulated deficit $ $
Total shareholders' equity (deficit) $ $
Total liabilities and shareholders' equity (deficit) $ $

9. Ratio analysis 1998-1999 Liquidity ratios 1998 1999 Current ratio
0,2650
2,0799
Cash ratio
0,1658
1,3903
Working capital $ $
Working capital to total assets
-0,9701
0,3171
Profitability ratios
Net profit margin
-827,56%
-596,18%
Gross profit margin
2,09%
12,64%
Operating profit margin
-832,94%
-599,90%
EBIT margin
-824,42%
-581,44%
Return on assets, ROA
-228,52%
-85,83%
Return on equity, ROE
137,75%
93,18%
Financial leverage ratios
Debt ratio
1,3553
0,4309
Debt-equity ratio
-0,8170
-0,4678
Equity to total liabilities ratio
-1,2240
-2,1378
Turnover ratios
Accounts receivables turnover
2,1087
6,9528
Accounts payable turnover
0,4280
0,8198
Working capital turnover
-0,2847
0,4539
Total asset turnover
0,2761
0,1440
Net asset turnover
-0,8633
0,2038

10. Answer no. 1
Between 1998 and 1999, bigger increase in the current assets than in the current liabilities → Current ratio excessive growth.
Increase between the revenues and their costs is proportional but the operating expenses grow bigger and the final result shows bigger losses.
Reduction of the debt ratio due to the growth in the current assets of the company.
Increase of the accounts receivables turnover ratio from one year to another. Therefore, it takes more time for the company to receive the payments from the customers while the accounts payable turnover keeps being similar.

11. Questions What could be said about NetFlix financial health?
What is the value of a new subscriber? What are expected cash flows of new subscribers for next five years?
Can Netflix afford to continue offering a free month of service to attract potential new subscribers?
Is Netflix ready for Initial public offering?

12. Subscriber model (1)
Used by businesses that have revenues dependent upon the number of subscribers or duration of their contracts.
For example, rental companies, magazines, newspapers, telephone/cell phone companies, cable television providers, Internet providers, and fitness centers.
Periodic access (under contract) to products and services for subscribers.
Basic elements of the model: subscription fees (paid monthly), expected number of discs rented, shipping and disc acquisition costs, and other subscriber-related cash flows.

13. Subscriber model (2)
Subscriber model to forecast Netflix’s future cash flow
Why NetFlix subscriber model?
NetFlix is a movie rental company that allows its customers to rent DVDs for a monthly fee.
NetFlix’s primary objectives are to acquire as many subscribers as possible, and to retain both newly acquired and already existing subscribers as long as possible, because once a subscriber is bound to NetFlix’s contract, the company books cash flow in advance from that subscriber, eliminating risk or uncertainty.
The longer NetFlix retains its subscribers, the higher the probability that subscribers’ loyalty develop.

14. Monthly shipping costs per subscriber
To calculate the value of new subscriber to Netflix, we need to calculate the costs of new subscriber first of all.
The costs of new subscriber consist of shipping costs and disc acquisition costs.
Disc shipping:
Trial month
Paid month
Discs to stock queue 4
Average viewed discs
4.3
Total discs shipped
8.3
Disc shipping cost 1
Total shipping cost per month

15. Value of new subscriber
Trial month
Paid month
Monthly costs:
Shipping
$8,30
$4,30
Disc acquisition
98,29
9,83
Total monthly cost
$106,59
$14,13
Total monthly revenue
19,95
Value
-$106,59
$5,82

16. NPV of a new subscriber 1st year scenario Subsequent year
Subscriber outcome
Probability
Month 1 (trial)
Month 2
Month 7
Month 12 2 3 4 5
Drop after 1st month
30%
-$106,59
$88,46
Drop after 6 months
42%
$117,57
Retain
28%
$64,03
$69,85
$158,31
Expected cash flows
$26,54
$49,38
$17,93
$19,56
$44,33
Expected cash flows per year
-$12,74
Discount factor
20%
1,0000
0,8333
0,6944
0,5787
0,4823
PV of expected cash flows
$16,30
$13,58
$11,32
$21,38
Exp. NPV of new subscriber
$49,83

17. Cash flow

18. Answer no. 2
NetFlix has a high acquisition cost per subscriber. It´s necessary to continue acquiring new subscribers and increase company´s market share.
NetFlix is allocating a large number of sales and marketing ($16.4 million in 1999) cost outlay is necessary because the company is still in its early stage of growth.
Will benefit from subscribers if they turn them into loyal ones, as potential competitors enter the online video rental market.

19. Questions What could be said about NetFlix financial health?
What is the value of a new subscriber? What are expected cash flows of new subscribers for next five years?
Can Netflix afford to continue offering a free month of service to attract potential new subscribers?
Is Netflix ready for Initial public offering?

21. Answer no. 3
Can afford and should continue offering new customers free trial month.
More likely to subscribe if they’ve had the opportunity to experience the service before.
70% retention rate after trial month, 40% after 6 months. Profits from the initial subscriber acquisition costs.
Once converted to paid status  present value of $49,83 per subscriber.
Best way to attract customers.
Eliminating free trials will affect the market share negatively. Could end up worse than years.

22. Questions What could be said about NetFlix financial health?
What is the value of a new subscriber? What are expected cash flows of new subscribers for next five years?
Can Netflix afford to continue offering a free month of service to attract potential new subscribers?
4. Is Netflix ready for Initial public offering?

23. Cash flows

24. Answer no. 4
Netflix doesn’t produce positive cash flows until 2003, therefore they should not go forth with its IPO at this time.
Ideal opportunity presents in This year cash flow stream is projected to more than double due to the increasing number of subscribers. That means having a better chance and favorable financial market.

25. Timeline of growth 1997: Foundation. 1998: Website launch.
1999: Monthly subscription launch.
2000: Offer for acquisition to Blockbuster for $50 million. Blockbuster declines the offer.
2002: Anticipated IPO (Initial public offering).
2003: Reaches 1 million subscribers.
2007: Delivers its billionth DVD and begins to move away from its original core business model of mailing DVDs by introducing video on demand via the Internet.
2010: Starts expanding its streaming service to the international market, starting with Canada.
2011: Latin America expansion. (Central America, Caribbean and South American countries).
2012: Europe expansion (UK and Nordic countries).
2015: Rest of European countries covered and starts with Japan and some other parts of Oceania (Australia, New Zealand and
2016: Asia. (Exception with regions subject to U.S. sanctions).

26. Evolution of subscribers
Reached 125 million of subscribers in April of 2018.
Source:

27. Evolution of share value
Growth of shares after IPO:

28. Conclusions
Success came thanks to flat-fee of unlimited rentals without due dates, late fees, shipping and handling fees. Comfort for users.
The strategy of offering a free month of service worked out and attracted new subscribers. According to the numbers (revenues) the company could afford to keep offering the service.
Correct decision of doing the initial public offering (IPO). Positive results come right the next year after it.
NetFlix has a direct dependency on a subscriber as it is the companies' main value - to obtain new subscribers and to retain their loyalty as long as possible.
As NetFlix expanded worldwide and provides its service for most of the countries in the world their biggest value remains the same.

29. Thank you for your attention!