Valuation Report

We at XYZ have established an understanding the ABC Company hereafter referred to as “the client” to include the nature purpose and objectives of the valuation agreement as is according to the USPAP. Any limitations or assumptions must be disclosed to the valuation analyst and included in the valuation report. We have established an understanding with the client and have there were no scope restrictions or limitations for analysis. In accordance with the Scope of Work Rule is USPAP, we must:

1. Identify the problem to be solved

2. Determine and perform the scope of work necessary to develop credible results

3. Disclose the scope of work in the report

The purpose of this report is to gain and understanding of Netflix, Incorporated by reviewing their financial statements as provided by management and work environment surrounding the business. Economic considerations have been made as well and the impact on Netflix, Inc. We considered all valuation approaches and selected the most applicable method to evaluate the financial position of the company. The evaluation is in the attached report.

· The History and Nature of the Business

· General Economic and Industry Outlook

· Book Value and Financial Position

· Approaches to Value

· Income Approach

· Discounted Cash Flow Method

· Cost of Capital

· Cost of Equity

· Cost of Debt

· Market Approach

· Reconciliation of Valuation Methods

· Conclusion of Value

· Appendix A – Assumptions and Limiting Conditions

· Appendix B – Valuation Representation/Certification

· Appendix C – Other Sources Consulted

· Appendix D – Exhibits

Table of Contents Understanding with the Client and Scope of Work 2 Executive Summary 3 The History and Nature of the Business 5 Market Area and Customers 5 Competition 5 Management and Key Persons 6 Stock and Stockholders 6 General Economic and Industry Outlook 6 Economic Indicators 6 Historical Business Cycle 7 Summary and Outlook 7 Book Value and Financial Position 8 Income Statement Analysis 8 Balance Sheet Analysis 9 Working Capital. 9 Total Assets 9 Interest-Bearing Debt. 9 Total Liabilities 9 Stockholder’s Equity 9 Projections 9 Approaches to Value 10 Income Approach 11 Present Value of Cash Flows 11 Discounted Cash Flow Method 11 Cost of Capital 12 Cost of Equity 13 Cost of Debt 14 Market Approach 15 Guideline Companies 15 Selection of Guideline Companies 16 Analysis of Guideline Companies 17 Reconciliation of Valuation Methods 19 Conclusion of Value 19 Appendix A – Assumptions and Limiting Conditions 20 Appendix B – Valuation Representation/Certification 20 Appendix C – Other Sources Consulted 20 Appendix D – Exhibits 21

Netflix has been an overachieving performer over the past five years and has a market capitalization value of $47 billion. The streaming of music, videos, TV, and network shows has become more popular Netflix has navigated these changes to capitalize on the market’s demands for entertainment. As technology has improved, the capability for devices to stream content has become more accessible and convenient. Their basic business model consists of movie studios and broadcasters releasing the rights to Netflix to distribute their content to monthly subscribers and in return receiving payment for the contribution. Additionally, Netflix original content has become more popular in the past few years and has gained a following in addition to the already comprehensive library of movies and shows included. The original Netflix model mailed DVDs to monthly subscribers who would return the movie when they were finished watching it. While the primary platform for streaming Netflix is mobile devices or home entertainment systems, DVDs still make up a portion of the business’s viewership. The business model for Netflix can be seen in Exhibit 1.1.

As mentioned earlier, Netflix competes with other entertainment streaming services like Amazon Prime Video, Hulu, HBO, and Direct TV. These services all provide similar content but present it to their subscribers in different packaging. Netflix has nearly 111 million paying customers globally with a market cap of $122 billion in 2017. The US market is more advanced than those internationally, but as customer growth continues this will most likely change. It is assumed that with household sharing subscriber growth will level off in the next few years and the challenge for Netflix to earn new paying customer will commence.

As of the valuation date the following management individuals and key persons of Netflix, Inc. are included in Exhibit 1.2. Reed Hastings the founder and CEO began Netflix in 1997 and has continued to build the company into the mega million entertainment streaming service that it is today. He is largely influential in the new content and development strategies for the future growth and without his knowledge of Netflix’s vision would be a mediocre performer in the streaming network space.

Facilities

The corporate headquarters of Netflix, Inc is Los Gatos, California and are sufficient for all administrative, software development, and content creation. Acquiring Netflix Inc. would not require the client to relocate any of this production.

As of the valuation date the following majority stockholders are included in Exhibit 1.3. The majority stockholders are mutual funds which blend Netflix stock with other high performing companies for sale.

As streaming online becomes the central mechanism for bringing entertainment content home, it is highly likely that Netflix will continue to grow and, in this growth, determining how they can increase their profit margins will be key. Acquiring content is a fixed cost for Netflix, so implying economies of scale, as the demand for content increases so do higher prices for consumers leading to higher revenues. Netflix had solidified a competitive advantage in the entertainment streaming industry by acquiring commitments from several of the largest cable network providers including ABC Family, NBC, FOX, Disney just to name a few. Families can subscribe for multiple users, customize what content is available to younger viewers in the home and monitor what shows are being watched. While the market may seem saturated with products like Amazon Prime Video, Hulu, HBO, and Direct TV, Netflix still is the most popular entertainment streaming service available in the United States and its value is a direct result of users, content quality, and popularity in the industry.

According to the Wall Street Journal, Netflix Inc. has increased in revenue by 33.46% in five years, increased net income by 79.45%, increased earnings per share by 74.63%, and increased gross margins by 84.77%. It is interesting to note that cash flow has decreased by 916.93% in five years. Subscriber growth will plateau at some point in the United States as account sharing has become popular among families combined with the multiple screen subscription option for users.

Netflix operates in the Broadcasting Media and Entertainment industry with nearly 53% of wi-fi households in the U.S. using some sort of entertainment streaming service. According to a report by comScore, Netflix leads with 75%, followed by YouTube (53%), Amazon (33%), and Hulu (17%). Nearly 49 million homes in the U.S. are connected to wi-fi and have ventured away from traditional entertainment sources like cable, direct TV, and satellite. While many argue that Netflix has reached market saturation for some time, the managing team believe that there is still room for growth both domestic and abroad.

Netflix, Inc.’s historical comparative income statements are presented in exhibit 2.1 and balance sheets in exhibit 2.2. Three years’ worth of financial data from their 2017 10-K annual reports are included for reference and determinate of the the final valuation.

Gross Profit – Netflix’s gross profit increased by 42.8% from $2.8 billion to $4.0 billion from 2016 to 2017. This was largely due to capitalizing on foreign emerging markets for viewership and increased subscriptions. Consideration was made for the lease commitments to movie producers and broadcasters.

Selling, General and Administrative Expenses – SG&A took a larger jump between 2017 and 2016 than from 2015 to 2016. As a percentage of revenue SG&G for 2017 represented 17% of net revenues and has remained consistent over the past three years.

Adjusted Income before Taxes – Adjusted income before taxes was approximately $485 million as of December 31, 2017. This was an increase of 42.8% from the previous year.

Adjusted Net income – Adjusted net income increased from $186 million to $558 million in 2017. That is nearly a 300% increase in one year. Taxes and expenses remained equal in percentage of revenue across all three years, so this increase in net income is largely due to the increased revenue stream.

Management projects that there is still room for subscription growth in the next five years. They anticipate growth of 30% increase in users and nearly the same in revenues. Consideration should be made for the saturation level of streamed entertainment because other competitors demand market shares as well.

Three approaches are traditionally used to determine value in an operating business including the income approach, market approach, and the asset approach. In determining the value of Netflix, both the income and market-based approaches will be used. Evaluation will be done based on the valuation that best represents the company.

Income Approach

The income approach calculates the value of the business in the present value given the financial data. For this valuation the discounted cash flow method will be used. This reflects the market rate of return expectations, market activity, and risk of investment.

Market Approach

The market approach uses comparison to other similar businesses or transactions to determine the value of the company. For this valuation comparison to like business will be used to determine the fair market value.

Asset Approach

The asset approach evaluates a company’s value by using one or more of the asset-based methods using assets net of liabilities. This approach is not necessary for companies that are operating profitably and can be evaluated by the income and market approaches.

Summary of Valuation

In our valuation of Netflix, Inc. both the income and market approach will be used to determine the fair market value. Under the income approach we will use the discounted cash flow method and under the market approach we will used the guideline public company method. The asset approach does not prove to be the best method for valuation because intangible assets primarily make up Netflix’s total assets.

The income approach uses earnings, cash flow, and dividend paying capacity to estimate the fair market value. Using the present worth of the future economic benefits discounted to the present value gives a valuation closely resembling the true value of the company.

Using the present value, with cash flows of $1.3 billion, -$341 million, and $696 million over the past three years at a rate of 26% in perpetuity as projected by management, the present value of the cash flows from 2015 to 2017 is $59.2 billion. Using the cost of capital to calculate the present value of the cash flows, Netflix is utilizing most of its cash to invest in long term commitments for Hollywood shows and original content creation.

The discounted cash flow method provides a valuation of a company’s cash discounted to the rate of risk associated. The DCF includes adjusted cash invested in capital to conclude that the present value of the Netflix, Inc as of July 10, 2018 is $61.2 billion. The difference with the DCF method is it includes taxes and reduces the final valuation by interest- bearing long term debt. At this time Netflix operates with 80% debt to finance its long-term commitments to broadcasters and directors creating original content for viewers. Consideration was made for growth of 26% in perpetuity as indicated my managements projections.

The cost of capital is used to determine how a company acquires capital for expenditures, advancement and growth. There are certain risks associated with gaining new subscribers and part of this relates to the cost of capital. At what rate can Netflix acquire capital and still profit? This was determined to be approximately 11%. Assuming that the perpetual growth rate of 26% does continue for the foreseeable future, the weighted cost of capital will slowly decrease because the funding needs are generated by revenues and capital will be used primarily to sustain Netflix products rather than acquire more users when the market reaches the saturation point. The risks associated with Netflix are uniquely attributable to their specific company as their WACC is particularly low for a company that has just turned over 5.7 times the revenues in the past three years. Formulating a strategic plan for the future, investors and owners should evaluate Netflix at the current revenue to net income ratios for accurate risk calculations.

The formula for calculating the average cost of capital is:

WACC= (ke X We) + (kp X Wp) + (kd/(pt)[1-t] X Wd)

WACC = weighted average cost of capital

ke = cost of common equity capital

W = percentage of common equity in the capital structure, at market value

Kp = cost of preferred equity

kd/(pt) = cost of debt (pre-tax)

t = tax rate

Wp = percentage of debt in the capital structure, at market value

See Exhibit 3.2 for calculations.

Using historical market transactions and stock sales, we have determined that the cost of equity is approximately 11%. As an investor the cost of equity is the equal to the required rate of return on an investment. As the company the cost of equity can be used to determine the rate of return on a project or business segment. Typically, equity costs more than debt because while debt is cheaper, it will be paid back leaving the company with nothing other than a clean balance sheet. While the cost of equity is higher than debt the Capital Asset Pricing Model (CAPM) can be used to analyze the higher rates of return. For Netflix, they have chosen to focus less on equity and more on debt to fund their strategic growth plans. Shareholders are mostly concerned with their return on investment and while Netflix has increased its net worth since its launch in 1997, some shareholders have become concerned with market saturation and slowly have pulled away from the stock. Firms use their cost of equity to compare their attractiveness of investments for internal projects, acquisition opportunities and stockholder appeal. Netflix has not chosen to invest largely in their equity, but as they reach a plateau in the market it would be our assumption that there may be a shift from debt focused to equity focused.

Modified CAPM formula can be summarized by:

E(Ri) = Rf + β X (RPm) + RPs ± RPc

E(Ri) = expected rate or return on the security i

R = rate of return available on a risk-free security as of the valuation date

β = beta

RPm = equity risk premium (market risk)

RPs = risk premium for small size

RPc = risk premium attributable to other company risk factors

See Exhibit 3.2 for calculations.

The cost of debt is the rate at which a company accumulates debt to cover expenses. After analysis of the financial statements it was determined to be around 2.7%. As Netflix has a substantial portion of long-term debt outstanding on its balance sheet it would be assumed they have chosen to use debt to further their commitments to stream content for viewers. The SG&A expenses have not increased in relation to revenues, so the debt is largely to solely increase content. As discussed above, the cost of debt is less than the 11% cost of equity. According to Forbes, Netflix has acquired nearly $1.5 billion in debt financing for new original content programs. The company "intends to use the net proceeds from this offering for general corporate purposes, which may include content acquisitions, production and development, capital expenditures, investments, working capital and potential acquisitions and strategic transactions," a press release reports. It is calculated that the cost per show is less than the paid subscription per watch. Calculations for cost of debt can be seen in Exhibit 3.2.

Under the market approach Netflix will be compared to two additional online streaming broadcasting companies to set a benchmark for their valuation in this report. This is a confirming appraisal approach to compare with the income approach discussed earlier in this report. Regardless of what assets are being valued, the market approach studies recent sales of similar assets, adjusting for differences in size, quantity or quality. The market values of the comparable are calculated using the share prices of the public companies. The values of the public companies are standardized by converting them to a multiple of an observable financial variable such as earnings before interest, taxes, depreciation and amortization (EBITDA).

Guideline companies are selected to compare a business to those in its industry. Netflix is by far the most popular online streaming broadcast service in its segment and by comparing it to two publicly traded companies within the same industry. For this comparison Disney and Comcast will be used to compare Netflix in the market approach. These companies would be similarly affected by economic and industry factors and give a comparative view to the broadcasting guideline companies. An independent analysis will be performed on both Disney and Comcast for accurate valuation of Netflix, Inc. as both Disney and Comcast hold a sizable share of the online streaming market and are publicly traded. Transactions of both companies are considered credible sources of information for the guideline public company method.

Disney and Comcast were selected for comparison because they hold a large portion of the market for entertainment broadcasting. Disney began with cartoon television shows and has developed a series of movies, theme parks, online streaming services, and vacations based on the characters developed by Walt Disney.

Disney – The Walt Disney Company along with its subsidiaries operates as entertainment across North America and the world. In 2017 they reported $55.1 billion in revenues and is listed as one of the most powerful brands in the world. Disney commits $3.26 billion dollars to licensing and publishing similar to Netflix committing to movie studios and major broadcast networks for content streamed online through their service. The market capitalization of Disney was $152.3 billion. Disney has not licensed many of its movies to Netflix and instead they have introduced their own streaming service for families to enjoy Disney movies, cartoons, and premium programming.

Comcast – Comcast operates as a media and technology company all across the world. Cable communications, cable networks, broadcast television, internet, voice, and XFINITY streaming. Revenues at year end 2017 were $84 billion nearly $30 million more than the Walt Disney Company. The market capitalization of Comcast was $142.6 billion and is based on a widely diversified media and entertainment from its own broadcast network. While its market cap is slightly less than Disney, their share price has decreased by 26%. As mentioned earlier, similar industries respond the same way to economic changes in the industry. Neither Disney nor Netflix experienced a similar drop in share price in recent months. In comparison to Netflix Comcast owns the majority of its subsidiaries rather than contracting movies and major broadcast networks shows on XFINITY.

The two publicly traded companies assessed in the guideline company method greatly outperform Netflix by the standard measures of performance. Their revenues and net income are nearly one hundred times greater and their debt ratios are much smaller. The maturity of both Disney and Comcast can be attributed to their larger revenues, yet the growth rates of Netflix have not been seen in companies like Disney and Comcast for nearly 20 years.

Revenue - Based on revenues Netflix ($11.6 billion) barely compares to Disney ($55 billion) and Comcast ($84 billion). It is likely that the subsidiaries and divisions of both Disney and Comcast contributed to such large revenues, while Netflix has a more streamlined product line in this stage of the business life cycle.

Debt to Equity Ratio – Netflix has the highest debt to equity ratio of 1.63 which is likely caused by the content commitments it added in the past year nearly $1.5 billion of debt financing. Disney has the lowest debt to equity ratio at .55 and Comcast lists at .96.

Net Profit Margin – Relative to their net revenues Comcast has a net profit margin of 26.79%, Disney 20.16%, and Netflix falling in last at 5.0%. Rapid growth has caused some growing pains for Netflix as the cost of revenue has not regulated to the level of revenues. As the company matures in the broadcasting industry, investors can except more level cost of sales and better profit margins.

Growth Rate – Netflix has grown at a fast past of 27.1% growth over the past three years. It is still in the growth phase of the business life cycle and President Hastings concludes that there is still room for growth in the next five years at the current pace. Disney has grown at a moderate 8% in the past three years with only conservative increases in growth. Slightly overperforming Disney, Comcast had an average growth rate of 10.4% in the past three years.

Net Income – Disney topped it off with $8.9 billion in net income in 2017, Comcast with $22.7 billion and Netflix falling in last with $585 million. If using ratios to compare revenue to net income Disney performed at 16%, Comcast the highest at 27% and Netflix following up with 5%. If Netflix were able to classify their commitments to movie studios and broadcasting stations as intangible assets on their balance sheet, the current ratio would be much less in comparison to these large mature companies that have limited their debt and primarily use operating income to fund their growth strategies and planning.

Share Price – While Netflix may be the new company on the block, its share price is much higher than both Disney and Comcast, nearly four times greater. Currently selling at $418.65, Netflix outperforms Disney selling at $108.25 and Comcast selling at $34.55. The risks associated with Netflix stock is somewhat higher than for Disney and Comcast because it is newer to the market and there is still so much growth. This leaves room for large economies of scale within the stock market and can affect the stock price fairly quickly if one majority shareholder decides to sell some of their stock in Netflix.

WACC – The weighted average cost of capital for all three companies is fairly close. Netflix does come in at 11% and both Disney and Comcast at 9%. As mentioned earlier the cost of capital is what companies use to determine the rate of return they need to see on a project or business segment before analyzing profitability. Divisions that are not performing well will most likely not receive capital funding in the following quarter due to the losses generated. Netflix has been able to reduce their WACC over the last three years and has seen rapid growth in their international subscriber’s market. Plans to increase the content available to international markets will help management evaluate the returns necessary to keep the international segment or do away with it if the profit margin doesn’t match the WACC.

Comparison of the guideline public companies provided a unique perspective on where Netflix fits in an already mature broadcasting entertainment industry. While Netflix did not meet the same goals as Disney and Comcast, in their own right performed very well and profited this year. The income approach gave a more detailed look at the present value of the company while the market approach provided more perspective to the net worth of Netflix at this point in time.

See Exhibit 4.2 for the reconciliation of the valuation methods used in this report.

After reviewing the two valuation methods used to calculate the value of Netflix, Inc. we conclude the fair market value of Netflix to be $60.8 billion. We have performed the valuation engagement as defined by the USPAP to determine the fair market value of Netflix, Inc. for the internal use of ABC company in preparation for purchase. There were no restrictions or limitations to the scope of this valuation on the date of evaluation.

1. The concluded fair market value is only valid on the date of the valuation

2. Financial Statements were provided by Netflix, Incorporated.

3. Public information, industry analysis, and statistics were from reliable sources.

4. Perpetuity Growth Rate = 26% (average growth rate three years) established by management projections.

I represent/certify that, to the best of my knowledge and belief:

1. The statements of fact contained in this report are true and correct.

2. The reported analysis, opinion, and conclusions of value are my honest conclusions.

3. I have no financial interest in the business or property related to this report.

4. My valuation engagement conforms to the guidelines set by the USPAP.

Yahoo Finance

Hitchner, James R. Financial Valuation: Application and Modesl, 4th ed. (Hoboken, NJ: John Wiley & Sons, 2017)

Netflix, Incorporated

The Walt Disney Company

Comcast & XFINITY

Uniform Standards of Professional Appraisal Practice, Appraisal Foundation