When it comes to Netflix, Michael Pachter remains a bear — even after seeing the company post standout quarterly results on Monday.
Long skeptical of the streaming-video company’s business model and its ability to generate meaningful returns for investors, the Wedbush analyst on Tuesday reiterated his “underperform” rating on Netflix’s shares.
He did increase his price target to $125 a share from $110, but that only underlines his pessimism; in recent trading, Netflix shares were trading at $336.92, up $29.14 a share, or about 9%.
In explaining his rating, Pachter pointed to Netflix’s ongoing cash burn. The company had a net outflow of about $284 million in its latest quarter, stemming from its operations and its investments in equipment and DVDs for its legacy business.
The company said Monday that it expected to continue burning through cash for the “several more years,” Pachter noted. Realistically, the company won’t be able to stanch the bleeding unless it dramatically raises prices — a move that could severely crimp its growth, he said.
“Until we see evidence that it can successfully deliver positive free cash flow, we advise investors to seek more compelling investment opportunities,” Pachter said in a research note. “We believe that Netflix’s valuation is unwarranted.”
While Netflix’s reported Q1 revenue and profits were in line with Wall Street’s expectations, it added 7.4 million subscribers, about 1 million more than analysts had forecast. Many of Pachter’s colleagues on the Street used Netflix’s results to issue bullish reports on the company and raise their price targets to the stock’s current level or beyond.
Even Pachter was impressed with that kind of subscriber growth.
“Netflix is absolutely delivering on its growth goals,” Pachter said, adding that the company “is clearly doing something right.”
But Netflix is essentially boosting its subscriber growth by underpricing its service, he said.
While the company posts a profit on its income statement, that accounting ledger accounts for only a portion of what it’s spending on producing and licensing movies and TV shows. Once you factor in all the money Netflix is sending out the door, the company’s cash flow is deeply in the red and getting worse.
Last year, the company’s free cash flow — which takes into account operating expenses and investments in property and equipment and other long-lived assets — was in the red by $2 billion. This year, the company expects an outflow of $3 billion to $4 billion.
To break even from a cash flow perspective, Netflix would have to raise its prices to about $15 a month globally, Pachter estimated; right now, it charges $11 a month in the US and about $9 internationally.
To be a significantly profitable business, he said, it would have to charge about $20 a month.
At that level, Netflix’s growth rate would almost certainly slow to a crawl, given the increasing number of competitors, all of which offer their services at significantly lower prices.
“In conclusion, we aren’t yet ready to drink the Netflix Kool-Aid,” Pachter said.
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