Netflix Financial Analysis

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(in 000s, except eps) FY2005A FY2006A FY2007A FY2008A FY2009E FY2010E FY2011E FY2012E FY2013ERevenues 682,213$ 996,660$ 1,205,340$ 1,364,661$ 1,364,661$ 1,364,661$ 1,364,661$ 1,330,544$ 1,297,281$ Operating Income (EBIT) 2,622$ 65,218$ 91,773$ 121,506$ 178,941$ 244,330$ 316,976$ 377,081$ 437,251$ Net Income 41,889$ 48,839$ 66,608$ 83,026$ 116,646$ 157,839$ 203,656$ 241,761$ 280,086$ EPS

Basic 0.78$ 0.78$ 0.99$ 1.36$ 1.91$ 2.59$ 3.34$ 3.97$ 4.59$ Diluted 0.64$ 0.71$ 0.97$ 1.32$ 1.86$ 2.51$ 3.24$ 3.85$ 4.46$

Netflix, Inc., incorporated in August 1997, is an online movie rental subscription service in the United States, providing approximately 7.5 million subscribers access to approximately 90,000 digital versatile disc (DVD) titles plus a growing library of more than 6,000 choices that can be watched instantly on their personal computers (PCs) and returned at their convenience using its prepaid mailers.

Why Should We Invest? Competitors are FAILING while Netflix is THRIVING Current growth stock poised for future growth based on

technological innovation Consistent , sustainable growth Scalable business model – as subscribers grow, the bottom line will

increase

Buy 1,000 SharesBuy 1,000 Shares

12/31/08 09/30/08Subscribers: beginning of period 8,672 8,411

Gross subscribers additions: during period 2,805 1,528

Gross subscriber additions year-to-year change 39.5% 17.8%

Gross subscriber additions quarter-to-quarter sequential change 36.5% 10.4%

Less subscriber cancellations : during period (1367) (1,267)

Subscribers: end of period 9,390 8,672

Subscribers year-to-year change 25.6% 23.4%

Subscribers quarter-to-quarter sequential change 8.3% 3.1%

Free subscribers: end of period 226 182

Free subscribers as percentage of ending subscribers 2.4% 2.1%

Paid subscribers: end of period 9,164 8,490

Paid subscribers year-to-year change 25.1% 24.0%

Paid subscribers quarter-to-quarter sequential change 7.9% 3.1%

Average monthly revenue per paying subscriber $ 13.58 $ 13.60

Churn 4.2% 4.2%

Subscriber information: 3 Months Ended

Ticker Summary:Ticker NFLXPrice $36.17 Market Cap 2.13BBeta 1.1152 Week Range $17.90-$40.90P/E 27.28

P/S 1.8

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Table of Contents

Company Overview……………………………………………………………………………………………………………………3

Competitors………………………………………………………………………………………………………………………………4

SWOT Analysis…………………………………………………………………………………………………………………………..5

Industry Outlook………………………………………………………………………………………………………………………..6

Investor Relations ……………………………………………………………………………………………………………………..8

Financial Ratios………………………………………………………………………………………………………………………….9

Pro Forma Income Statement………………………………………………………………………………………………….12

Relative Valuation……………………………………………………………………………………………………………………13

Discounted Cash Flow Valuation………………………………………………………………………………………………14

DCF Assumptions……………………………………………………………………………………………………………………..15

Final Points and Recommendation…………………………………………………………………………………………..16

Financial Statements………………………………………………………………………………………………………………..17

Appendix…………………………………………………………………………………………………………..…………………….21

ValueLine …………………………………………………………………………………………………………..……………………22

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Company Overview

Netflix is the largest online movie rental service operating in the United States with over 100,000 titles. They have both a physical rental service in which DVDs or Blu-Ray discs are mailed to the customer and an online video streaming service with roughly 9.4 million subscribers.1 As a subscriber, you have access to both services under the same fee.

Subscription Plans

Plan Rentals/Month Price/month Online Streaming Hours

1 DVDs at a Time 2 4.99 2 Hours1 DVDs at a Time Unlimited 8.99 Unlimited2 DVDs at a Time Unlimited 13.99 Unlimited3 DVDs at a Time Unlimited 16.99 Unlimited4 DVDs at a Time Unlimited 23.99 Unlimited5 DVDs at a Time Unlimited 29.99 Unlimited6 DVDs at a Time Unlimited 35.99 Unlimited7 DVDs at a Time Unlimited 41.99 Unlimited8 DVDs at a Time Unlimited 47.99 Unlimited

DVD/Blu Ray RentalAs a customer, you create a queue of movies/television DVDs or Blu Rays in the order you would

like them sent to you. Netflix when then mail you the movies. Once you are finished with them, you reseal them in the prepaid envelope and drop them in the mailbox. If you drop the discs in Monday, you will most likely have your next videos on Wednesday. Blu Ray Discs are also available and can be accessed by any plan by being charged an additional $1 per month.2

Online StreamingNetflix currently has over 12,000 titles available in their watch instantly service. The consumer

can watch an unlimited amount of content instantly on all plans except the cheapest one. This section is also continuing to grow daily. The consumer can watch content on his or her computer or on a television via a variety of devices outlined in the Appendix. Furthermore, as time goes on, it is very likely more and more Blu Ray Disc players and digital video recorders will come with the Netflix streaming service built in.

1 Netflix 4th Quarter 2008 Earnings Release2 Netflix.com

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Competitors

Blockbuster Inc. (BBI): Blockbuster Inc. is headquartered in Dallas, TX and was founded in 1982. Blockbuster Inc. operates approximately 7,500 franchised video rental stores internationally and is the largest video rental chain in the United States. They rent and sell movies, video games, and entertainment related merchandise through their franchise stores and website. The company has several subsidiary brand names and concepts, including Game Rush stores in Canada, Mexico, and Italy and Xtra-Vision stores in Ireland. Blockbuster reported a negative 85 million dollar net income loss as of Jan. 6th, 2008. (Reference Appendix 1 for prices)

Movie Gallery , Inc. (MVGR.PK) : Based out of Wilsonville, Oregon , Movie Gallery inc. specializes in home entertainment, specifically movie , video game , and DVD/ Blu-ray rentals. Movie Gallery is the 2nd largest video rental store in the US and has several subsidiary brands, including Hollywood Video, Movie Gallery, and Game Crazy stores. There are approximately 3,290 retail locations operated under the aforementioned brand names in North America today. Each brand focuses on enhancing the customer experience through exceptional customer service and creating a unique venue to buy, sell, and exchange movies/video games. It is important to note that Movie Gallery filed for Chap. 11 bankruptcy as of Oct. 16th, 2009. Movie Gallery stores reported a 623 million dollar loss Jan. 6th, 2008. This can be attributed to an out of control cost structure and outdated business model.

Redbox (Private): Redbox automated retail LLC is a leading retailer/ renter of DVD’s through their automated Kiosk’s located at McDonalds, Wal-Mart’s, and over 12,000 retail locations. Their business model emphasizes low-cost DVD rentals ($1) and the convenience of redbox by being able to drop off redbox movies at any location across the U.S. Redbox also allows customers to reserve and return movies through their website, redbox.com.

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SWOT Analysis

S trengths

First Mover’s Advantage – Netflix essentially created online move rental Rated #1 in online retail customer satisfaction by independent surveys from Nielsen Online. True “No Late Fees” Ability to recommend future movies using proprietary software based on the user’s movie preferences. Intuitive queuing system allows to users to create long lists of movies to be delivered in a particular order Able to provide over 95% of their subscribers with 1-day delivery due to their 100+ shipping points. Netflix continues to grow net Income and revenues while competitors are near bankruptcy Netflix has around 75% of all online movie subscribers.

W eaknesses

People like being able to go in the video store and get their movies. Consumer Discretionary - people might stop renting movies or cut back on rentals No Games. For people who have kids or just people who play video games, the fact that Netflix does not

offer video games could be a little bit of a turn-off since they would still have to go into a blockbuster to rent their games.

If an unlimited subscriber is turning over their DVDS fast enough Netflix will lose more on delivery costs than they make on subscription costs, however this is extremely unlikely.

O pportunities

Online Streaming opens access to potential new customers Netflix has deals with companies to be able to stream Netflix through the devices to the TV automatically

and the potential to work out more deals They offer a full Blu-Ray selection while Blockbuster and other competitors do not. DVD rentals are

approximately a $9 billion business and Netflix is poised to gain more market share as more people move to online movie rental

T hreats

Video on Demand services that many cable companies offer Apple and Amazon are also offering access to movies online. Redbox and other automated kiosks are stealing customers from both video stores and Netflix. A price drop in online movie rentals by competitors. could steal customers

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Industry Outlook:

Looking at the video rental industry, it is important to examine the relative market share of each competitor. Of the estimated 9.5 billion dollar rental market3 for video/DVD, the following companies dominate the movie rental industry landscape:

Year BBI NFLX MVGR Total Mkt Size‘08 5,542,400 1,364,000 2,452,442 9,358,842‘06 5,523,000 996,000 2,541,930 9,060,930

BBI 59%NFLX

15%

MVGR26%

'08 Relative Mkt Share

BBI 61%NFLX

11%

MVGR28%

'06 Relative Mkt Share

It is clear that Netflix is encroaching upon and cannibalizing market share. Both Blockbuster and Movie Gallery have suffered at the hands of Netflix. Despite sluggish revenue growth, a closer examination of NI and subsequent store closures yields some insight into the antiquated business models dragging BBI and MVGR down.

Year BBI NFLX MVGRNet Income ‘08 -73,000 83,000 -622,398Net Income ‘06 50,500 49,082 -552,000

*Values in Millions of US ($)

3 Constructed from Annual Sales Revenues of BBI,NTFLX, and MVGR , the 3 largest video rental companies in the US

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Store Fronts as of 2006 Store Closures4 Total Stores in Operation as of 2008

BBI 8360 (530) 7830MVGR 4430 (940) 3490

The brick and mortar video rental store may be out of date. Movie Gallery Inc. filed for Chapter 11 bankruptcy as of Oct. 9th, 2008, struggling under the burden of a heavy debt load and will close over 520 stores in restructuring efforts.5 It is clear that there will be considerable opportunity for Netflix if MVGR stores continue to remain unprofitable. Blockbuster has also recently closed an additional 530 unprofitable store fronts, representing about 6 % of its revenue base.6 The void created by additional store closures will undoubtedly benefit Netflix, especially in smaller communities. The yoke of the brick and mortar store front may be too unbearable for both BBI and MVGR to overcome.

Industry Metrics – Netflix:7

‘08 ‘07 ‘06 ‘05Churn 4.20% 4.30% 4.10% 4.50%

Subscriber Acquisition cost $26.67

$40.88 $42.96 $38.77

Netflix has managed to keep its turnover from subscribers relatively low while managing marketing costs. Blockbuster recently started its TOTAL ACCESS program to compete with Netflix’s unique offering and Movie Gallery has no such service. Consequently, there is no information on churn or acquisition costs for BBI or MVGR. In summary:

Netflix scalable business model should equate into lower costs and greater economies of scale as more subscribers opt to sign up for Netflix.

Store closures by BBI and MVGR will result in additional revenue and greater market share for Netflix.

BBI and MVGR may not be able to shed the yoke of their brick and mortar stores and effectively compete with Netflix in the coming years.

4 2007 Blockbuster Annual Report, http://www.costar.com/News/Article.aspx?id=9B6C725676E6A7711B4919E137DB53735 http://www.msnbc.msn.com/id/21324720/6 http://www.alleyinsider.com/2008/3/blockbuster_q4__not_too_bad__blockbuster_future__not_so_good__bbi_7 Churn = customer cancelations/sum of gross subscribers + additional subscribers /3 monthsAcquisition cost = Increase in marketing expense/additional subscribers

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Netflix Investor Relations:

We have contacted investor relations several times, but they have failed to contact us. Here are the questions we have submitted to them. If we receive answers, we will issue an addendum to the report.

1) How will the current economic crisis affect Netflix subscribers? Do you anticipate increased churn or sluggish growth in new subscribers as a result?

2) Is Netflix looking to pursue other distribution venues such as PS3, cable, Wii via streaming content? What deals or agreements does Netflix anticipate entering into?

3) Can you comment on the developments made on your streaming video service? Does Netflix have any plans to enter into the video-game rental segment?

4) Who do you view as your “true” competitors?

5) What new projects or initiatives is Netflix undertaking to add value to the customer experience?

6) Do you expect subscriber acquisition costs to substantially increase given the increasingly competitive environment Netflix operates in?

7) Fulfillment expenses represent a significant % of Revenues (close to 10-12 % annually). Do you expect these %’s to substantially increase due to postal rate increases? What other factors might impact fulfillment expenses?

8) Innovation and technology seem to drive Netflix and keep them ahead of the curve… Do you expect Netflix to continue to invest in R&D at current levels (4-5%) or lay off?

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Financial Ratios

Profitability:

2005 2006 2007 2008Operating Margin 0.38% 6.54% 7.61% 8.90%Gross Margin 31.73% 37.09% 34.78% 33.30%Profit Margin 6.14% 4.90% 5.53% 6.08%ROA 11.49% 7.72% 9.75% 13.44%ROE 18.51% 11.81% 15.50% 23.92%

Profitability Comparison:

2008 NFLX BBI MRFY MVGR MRFY

Operating Margin 8.90% 0.71% -23.00%Gross Margin 33.30% 51.69% 53.35%

Profit Margin 6.08% -1.33% -24.90%

ROA 13.44% -2.70% -92.06%

ROE 23.92% -11.26% 71.34%

Netflix’s profitability has been trending upwards for the past few years. Their profit margin has grown by around 50 basis points each year in the past 3 years. Their rest of their numbers increased from 2007-2008 except gross margin, which dropped about 150 basis points. However, we feel that drop is insignificant

Liquidity

2005 2006 2007 2008

Current Ratio 1.77 2.21 2.07 1.67

Quick Ratio 1.77 2.21 1.99 1.59

Liquidity Comparison

2008 NFLX BBI MRFY MVGR MRFY

Current Ratio 1.67 1.02 0.26

Quick Ratio 1.59 0.76 0.12

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The current and quick ratios have decreased in response to a share buyback program by Netflix and investments in their content library. Consequently, resources have been shifted to help fund future revenue growth in lieu of liquidity, but Netflix’s liquidity is adequate to meet any obligations that should arise.

Asset Management:

2005 2006 2007 2008

Total Asset Turnover 1.87 1.57 1.76 2.21 Fixed Asset Turnover 16.96 17.96 10.65 10.92

Asset Management Comparison:

2008 NFLX BBI MRFY MVGR MRFYTotal Asset Turnover 2.21 2.03 3.70 Fixed Asset Turnover 10.92 11.97 22.97

Days Sales in Inventory - 46.88 47.83 Average Collection Period - 7.45 -

Asset Management is doing fairly well. Their Fixed Asset Turnover fell off in 2007 but we believe that is because they spent more money on distribution centers. The TATO has increased steadily over the years, signaling efficient use of assets.

Debt Management:

2005 2006 2007 2008

D/E Ratio 0.61 0.53 0.59 0.78

Times Interest Earned N/A 53.90 77.25 49.43

Equity Multiplier 1.61 1.53 1.59 1.78

Debt Management Comparison:

2008 NFLX BBI MRFY MVGR MRFY

D/E Ratio 0.78 3.17 (1.77)

Times Interest Earned 49.43 0.44 (3.81)

Equity Multiplier 1.78 4.17 (0.77)

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D/E has increased slightly over the past few years, to help finance additional growth. Netflix’s debt load is considerably less than that of BBI and MVGR, both of which are struggling under massive debt loads. Netflix’s TIE ratio demonstrates that they generate ample amounts of revenue to cover their debt obligations. This compares quite favorably to both BBI and MVGR, which are struggling to make payments to their creditors and could spell bankruptcy for both.

Extended Dupont Analysis:

2005 2006 2007 2008

Profit Margin 6.14% 4.90% 5.53% 6.08%TATO 1.87 1.57 1.76 2.21

Equity Multiplier 1.61 1.53 1.59 1.78

ROE 18.51% 11.81% 15.50% 23.92%

Extended Dupont Comparison:

2008 NFLX BBI MRFY MVGR MRFY

Profit Margin 6.08% -1.33% -24.90%TATO 2.21 2.03 3.70

Equity Multiplier 1.78 4.17 -0.77

ROE 23.92% -11.26% -71.03%

From 2006 on ROE has grown at a steady rate partly due to increasing profit margins. This shows that ROE is increasing in part because of profit and not just because of more use of debt as some companies will do to finance their expansions.

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Pro Forma Income Statement

(in 000s, except eps) FY2005A FY2006A FY2007A FY2008A FY2009E FY2010E FY2011E FY2012E FY2013ERevenues 682,213$ 996,660$ 1,205,340$ 1,364,661$ 1,569,360$ 1,804,764$ 2,075,479$ 2,334,914$ 2,626,778$ Cost of Revenues 465,775 626,985 786,168 910,234 1,020,084 1,155,049 1,307,552 1,447,646 1,602,334 Gross Profit 216,438$ 369,675$ 419,172$ 454,427$ 549,276$ 649,715$ 767,927$ 887,267$ 1,024,443$ Operating Expenses

Technology and Development 35,639 47,831 70,979 89,873 116,835 151,885 197,451 256,686 333,692 General and Administrative 180,164 261,423 270,616 249,375 260,000 260,000 260,000 260,000 260,000 Gain on Disposal of DVDs (1,987) (4,797) (7,196) (6,327) (6,500) (6,500) (6,500) (6,500) (6,500) Gain on legal settlement - - (7,000) - - - - - -

Total Operating Expense 213,816 304,457 327,399 332,921 370,335 405,385 450,951 510,186 587,192 Operating Income (EBIT) 2,622$ 65,218$ 91,773$ 121,506$ 178,941$ 244,330$ 316,976$ 377,081$ 437,251$ Other Income (net) 5,346 14,694 19,152 9,994 12,281 14,423 16,887 19,248 21,904 Income before Taxes 7,968$ 79,912$ 110,925$ 131,500$ 191,222$ 258,753$ 333,863$ 396,329$ 459,155$ Provision for Taxes (33,921) 31,073 44,317 48,474 70,752 95,739 123,529 146,642 169,887 Net Income 41,889$ 48,839$ 66,608$ 83,026$ 120,470$ 163,014$ 210,334$ 249,687$ 289,268$ EPS

Basic 0.78$ 0.78$ 0.99$ 1.36$ 1.98$ 2.67$ 3.45$ 4.10$ 4.75$ Diluted 0.64$ 0.71$ 0.97$ 1.32$ 1.92$ 2.59$ 3.35$ 3.97$ 4.60$

Shares OutstandingBasic 53,528 62,577 67,076 60,961 60,961 60,961 60,961 60,961 60,961 Diluted 65,518 69,075 68,902 62,836 62,836 62,836 62,836 62,836 62,836

Netflix, Inc. Pro Forma Income Statement

Revenues

For Growth in revenues we used a 15 % annual growth rate. We feel that this is an appropriate rate they expand ways to reach customers and the typical brick and mortar stores are failing. In our estimates for 2012 and 2013 we use a 12.5% annual growth rate.

Cost of Revenues was on average 65% of revenues in years past so we used that rate in 2009 and dropped it 1% per year into perpetuity. We did this because they said as they increase subscribers the cost of revenues will drop due to economies of scale.

Operating Expenses

For Technology and Development we increased the previous year by 30%. To get this number we took the average and took into account that they probably had a large investment to develop the technology to stream over the internet so lowered it a little bit

For General and Administrative Expenses we kept it constant at 260,000 due to these expenses being around that number regardless of revenue growth.

Gain on Disposal of DVDS was kept in line with the previous year due to us not knowing exactly how many DVDs are in their collection, and which of those they actually own.

Interest Expense

We set Income Expense at 2000 which is more than the 3 yr average. We grew Interest and other income at .91% because that is what it was a percent of revenue in 2008.

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Tax Rate

Tax Rate was at 37% in 2008 and we felt that this was appropriate to continue with because it dropped 2% from 2007-2008 and we felt that they would keep it low.

Shares Outstanding

We kept the Shares Outstanding constant from the year 2008 on. We believe that we could not accurately estimate a figure because they authorized a share buyback of 175 million in 2009.

Relative Valuations:

P/E Valuation8 Projected P/E 2009 Pro Forma Projected EPS

Resulting P/E Valuation

Trailing P/E: 27.285 year P/E: 33.7

27.28 1.91 52.10

P/E ratios are often the best indicators of the value of a stock. In looking at the valuation from several vantage points, we decided to use a more conservative estimate and assumed that Netflix would continue to trade at the same P/E multiple, despite Netflix’s status as a high profile, growth stock. Investors are often willing to pay higher price per dollar of earnings if a stock is perceived as high growth

P/S Valuation9 Projected P/S 2009 Projected Sales/Share

Resulting P/S Valuation

Trailing P/S: 1.85 year P/S: 1.8

1.8 24.63 44.33

Revenues are subject to less manipulation than earnings figures are. Consequently, we thought it might be appropriate to provide a different perspective and use a P/S valuation for Netflix. To be consistent with our P/E valuation, we also assumed that the P/S ratio would continue to trade at the same levels throughout 2009. The average P/S ratio has remained relatively constant for the past five years so we thought that this would be an appropriate proxy for our projected P/S.

8 www.reuters.com9 www.reuters.com

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DCF Valuation:

2006 2007 2008 2009E 2010E 2011E 2012E 2013ESales $996,660 $1,205,340 $1,364,661 $1,569,360 $1,804,764 $2,075,479 $2,334,914 $2,626,778EBIT $65,218 $91,773 $121,506 $178,941 $244,330 $316,976 $377,081 $437,251Tax Rate 39% 39% 39% 37% 37% 37% 37% 37%Depreciation $16,648 $22,219 $32,454 $30,822 $35,445 $40,762 $45,857 $51,589Fixed Capital I nvestments $27,333 $44,256 $43,790 $50,340 $57,891 $66,574 $74,896 $84,258

Working Capital I nvestments -$59,307 $4,658 $10,112 $12,992 $14,941 $17,182 $16,466 $18,524

FCFF $88,405 $29,287 $52,671 $80,223 $116,541 $156,701 $192,056 $224,275

FCFF=EBIT(1 - Tax Rate) + Dep - FC INV - WC INV

Terminal Value in 201310

VL = (FCFF0*(1+gL))/(WACC-gL)

VL = ($224,275.08*(1+.04))/(.12-.04)

VL = $2,915,576.07WACC=12%

Long Term Growth=4%

Target Price WACC=12%

PV of FCFF 2009-2013 $525,384.73

PV of TV $2,915,576.07

PV of FCFF $3,440,960.79

Plus Cash and Cash Equivalents $139,881.00

Less Long Term Debt $37,988.00

PV of Equity $3,542,853.79

Target Price $54.58

10 Bloomberg.com

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DCF Assumptions:

Growth Rate: - 15% through 2011, 12.5% through 2013. Please refer to the Pro-Forma section of the report for details regarding why these growth rates were selected. As for the growth rate after year 2012, 4% was selected. This was done to mirror the low end of average GDP growth.

Tax Rate: -37%. Please refer to the Pro-Forma for an explanation of why this is chosen.

Depreciation: -This is value is assumed to be 1.96% of sales. This is the average depreciation percentage of sales over the last three years.

Fixed Capital Investments: -This has not varied too significantly in relation to sales the past three years. Therefore the average percentage of sales (3.21%) over the past three years was used to determine fixed capital investment.

Working Capital Investment: -Change in working capital investment was a very large negative number in 2006, but has leveled off since then. We decided to use calculate working capital as 6.35% of the change in sales from year to year. This is the same percentage that occurred in 2008. The 2007 percentage was only 2.23% but because we feel fairly uncertain as to what exactly will happen with working capital, we chose to go the more conservative path.

Weighted Average Cost of Capital (WACC): -Netflix is an interesting company in that virtually of their long term debt is in leases and not traditional debt. Because the lease terms were not revealed in Netflix’s 10K or any other documents we could locate, we could not calculate a cost of debt figure for Netflix. Therefore we consulted Bloomberg to obtain the WACC number of 12%.

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Final Points:

Competitors are failing while Netflix is thrivingo Movie Gallery has declared bankruptcy, and Blockbuster is not even turning a profit

anymore. Netflix is the only publically traded company in the movie rental doing well. Scalable business model

o As Netflix’s revenue increases, their cost of goods sold should not increase as much as revenues. Their large network of mailing centers and implementing automation measures makes their business model very scalable.

History of retaining subscriberso As seen by Netflix’s excellent churn ratio, once people start subscribing to Netflix, they

tend to stay with it. Poised for the future with online video streaming service

o While not expected to really take off for several years, Netflix is already preparing for the future by implementing their online video delivery service now.

Implemented share buyback programo Share repurchase program up to $175 million was recently approved by the Netflix

board.11 This is a strong indicator for the health of the company.

Recommendation:

Buy 1,000 shares of NFLX

11 Netflix 4th Quarter Earnings Report 2008

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Appendix 1:

Blockbuster Total Access Pricing Schedule:

3 DVDs at a time 2 DVDs at a time 1 DVD at a timeUnlimited Mail/Store Unlimited Mail/Store Unlimited Mail/Store34.99 + tax 29.99 + tax 21.99 + tax

3 DVDs at a time 2 DVDs at a time 1 DVD at a time 1 DVD at a timeUnlimited Mail Unlimited Mail Unlimited Mail 2 per month5 free in store per month 3 free in store per month 2 free in store per month 2 free in store per month19.99 + tax 16.99 + tax 11.99 + tax 9.99 + tax

3 DVDs at a time 2 DVDs at a time 1 DVD at a time 1 DVD at a timeUnlimited Mail Unlimited Mail Unlimited Mail 2 per month1.99 in store 1.99 in store 1.99 in store 1.99 in store 15.99 + tax 13.99 + tax 8.99 + tax 3.99 + tax

Blockbuster by Mail

Blockbuster Total Access

Blockbuster Total Access Premium

Devices compatible with Netflix:

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Original Discounted Cash Flow Valuation Correction (15% Sales Growth through 2011, 12.5% for 2012-2013)

2006 2007 2008 2009E 2010E 2011E 2012E 2013E

Sales$996,6

60.00$1,205,3

40.00$1,364,6

61.00$1,569,3

60.15$1,804,7

64.17$2,075,4

78.80$2,334,9

13.65$2,626,7

77.85

EBIT $65,21

8.00 $91,773

.00 $121,50

6.00 $178,94

1.15 $244,32

9.73 $316,97

6.17 $377,08

0.91$437,25

1.21

Tax Rate 39% 39% 39% 37% 37% 37% 37% 37%

Depreciation$16,64

8.00$22,219.

00$32,454.

00 $30,821

.88 $35,445

.16 $40,761

.94 $45,857

.18 $51,589

.33

Fixed Capital Investments

$27,333.00

$44,256.00

$43,790.00

$50,339.72

$57,890.68

$66,574.28

$74,896.06

$84,258.07

Working Capital Investments

-$59,30

7.00$4,658.0

0$10,112.

00$12,992.

12$14,940.

94$17,182.

08$16,466.

16$18,524.

43

FCFF$88,40

4.98$29,286.

53$52,670.

66$80,222.

96$116,54

1.28$156,70

0.57$192,05

5.93$224,27

5.08

Long Term Growth 4.00%

WACC 12.00%

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Terminal Value in 2013 $2,915,576.07

PV of Terminal Value $1,654,376.16

Target Price

PV of FCFF 2009-2013 $525,384.73

PV of TV $1,654,376.16

PV of FCFF $2,179,760.89

Plus Cash and Cash Equivalents $139,881.00

Less Long Term Debt $37,988.00

PV of Equity $2,281,653.8

9

Shares Outstanding 64912.915

Target Price $35.15

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Discounted Cash Flow Valuation with 19% Sales Growth (ValueLine Rate) through 2011, 16.5% for 2012-2013

2006 2007 2008 2009E 2010E 2011E 2012E 2013E

Sales$996,6

60.00$1,205,3

40.00$1,364,6

61.00$1,623,9

46.59$1,932,4

96.44$2,299,6

70.77$2,679,1

16.44$3,121,1

70.66

EBIT $65,21

8.00 $91,773

.00 $121,50

6.00 $198,04

6.41 $290,31

3.35 $399,92

7.20 $507,87

7.97$630,06

4.40

Tax Rate 39% 39% 39% 37% 37% 37% 37% 37%

Depreciation$16,64

8.00$22,219.

00$32,454.

00 $31,893

.95 $37,953

.79 $45,165

.02 $52,617

.24 $61,299

.09

Fixed Capital Investments

$27,333.00

$44,256.00

$43,790.00

$52,090.67

$61,987.89

$73,765.59

$85,936.91

$100,116.51

Working Capital Investments

-$59,30

7.00$4,658.0

0$10,112.

00$16,456.

69$19,583.

46$23,304.

31$24,083.

17$28,056.

89

FCFF$88,40

4.98$29,286.

53$52,670.

66$88,115.

83$139,27

9.85$200,04

9.25$262,56

0.28$330,06

6.26

Terminal Value in 2013 $4,290,861.39

PV of Terminal Value $2,434,749.98

Long Term Growth 4.00%

WACC 12.00%

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Target Price

PV of FCFF 2009-2013 $686,249.26

PV of TV $2,434,749.98

PV of FCFF $3,120,999.25

Plus Cash and Cash Equivalents $139,881.00

Less Long Term Debt $37,988.00

PV of Equity $3,222,892.25

Shares Outstanding 64912.915

Target Price $49.65

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DCF Tables

15% Sales Growth through 2011, 12.5% for 2012-2013

WACC

13.00% 12.00% 11.00% 10.00% 9.00%

Long Term Growth

4.00% $31.10 $35.15 $40.37 $47.34 $57.13

5.00% $34.04 $39.07 $45.79 $55.21 $69.37

6.00% $37.83 $44.30 $53.37 $67.01 $89.76

19% Sales Growth (ValueLine Rate) through 2011, 16.5% for 2012-2013

WACC

13.00% 12.00% 11.00% 10.00% 9.00%

Long Term Growth

4.00% $43.72 $49.65 $57.30 $67.54 $81.91

5.00% $48.05 $55.42 $65.28 $79.11 $99.92

6.00% $53.62 $63.11 $76.44 $96.48 $129.94

Each table shows the resulting target stock price for the respective WACC and long-term growth rate. For example, in the first table a WACC of 11% and a long-term growth rate of 5% equals a $45.79 target price.

Conclusion

While our original very conservative DCF valuation no longer provides a satisfactory target price, this should not be cause to immediately dismiss Netflix. The ValueLine growth rate DCF is a very plausible scenario given Netflix’s new streaming initiative, their scalable business model, and opportunity to cannibalize on the market of the other failing rental companies. Furthermore, the table of target prices based on different WACCs and long term growth rates shows this valuation’s extreme sensitivity to numbers that are very difficult to estimate.

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