Netflix bear explains why he changed his outlook on the stock

Wedbush Equity Research Analyst Michael Pachter joins Yahoo Finance Live to discuss his call on Netflix stock as well as the outlook for the streaming company.

Video transcript

- From retail to rescale, as our producers put it, Wedbush Securities is upgrading Netflix from neutral to outperform, stating that while they don't expect the streaming giant to return to 2021 levels anytime soon, they do believe Netflix is positioned to exceed its Q2 guidance. Joining us to discuss is Michael Pachter, Wedbush equity research analyst. Michael, you got a lot of people talking with your note because you were one of the most bearish on Netflix.

What changed?

MICHAEL PACHTER: Share price changed. So the stock was overvalued in the $600s. I think it peaked at $690. It's undervalued in the $180s. And you know, when it dropped from $690 to $340, I upgraded to neutral last quarter. And it just kept drifting lower, and there's just a point where 220 million subscribers represents real value. This is not a dumb management team. They're very, very smart.

They have a ton of content, and they've made tens of billions of dollars of investment in content. They're spending nearly $20 billion this year. And they just have finally gotten to the point where they're ready to leverage that investment. And modest growth in revenue is going to drive big growth in profit. I think that the street heard them miss the subscriber number. They guided to plus 2.5 million, and they delivered minus 200,000. And then they guided to another minus 2 million this quarter.

And I think the street thinks they're going to zero. They are not. So I think that if you look at every other streaming service, they added subscribers during the quarter that Netflix lost them. So net, it was a big positive, and I think this is going to normalize. I think ultimately, you're going to see streaming continue to grow because people are cutting the cord, or shaving cable. And I think that Netflix is going to always be the anchor subscription.

What they have to do is reduce churn, and they're taking steps to do that with their crackdown on password sharing, their introduction of an ad-supported tier, which will be lower priced. I think they need to stabilize their content spend, and they're already sounding like they're doing that. And when they start delivering leverage, the stock's, I think, going to rip right up to my $280 price target, less than half of where it was six months ago but 40% upside from here.

- Yeah, and Michael, again, certainly, a pretty rough ride for Netflix so far, I believe down 70% year to date. But the story for Netflix is kind of emblematic of what's been going on to other tech stocks, as well. And you kind of hear this-- these stories about analysts saying well, maybe we're shifting to more of a cash flow type of situation for these companies, as opposed to the high growth that we have been seeing over let's say the last decade or more.

So do you think that's also applicable to Netflix in such a way that maybe the net subscriber adds shouldn't be the big focus for people watching the stock in the quarters to come.

MICHAEL PACHTER: Yeah Brian, 100%. I mean, I downgraded these guys to sell in November of 2011, and I wrote about a 20-page note talking about cash flow. Cash flow was negative every single year following, until, I think, 2020, first year of COVID. So they burned through cash, up to as much as $3 billion a year. Cash flow was the story. They were positive $1.9 billion in 2020 or 2021. They're turning negative again, flattish this year.

But they're positioned to generate a ton of cash, and they're at the point where earnings is a proxy for cash. So we're looking at them making $10, $12 a year this year. And again, who knows? Let's, let's them get through one more quarter. And $14, $15 a year in a couple of years, with $450 million shares. So we're talking about generating $6, $7 billion in free cash flow. I think that's coming relatively soon, and I think when the market sees that, they're going to bid the shares up to $280.

- You know, Michael, there's been a lot of talk about how to get more subscribers on board, but I wonder what you think about just the content offering. At the end of the day, it is about the content on these streaming sites. And some would argue that while Netflix has really gone in on the quantity, in terms of the amount they offer, the quality has kind of dropped.

MICHAEL PACHTER: Yeah, Netflix is the Taco Bell or McDonald's of video, and HBO is the Ruth's Chris or Morton's Steakhouse. So sure, you go into HBO expecting to get knocked out by a handful of great shows. You go to Netflix expecting to fill your time. And you know, Netflix consumption is something north of 30 hours a month. So sure, it's bite size, but that's kind of true of broadcast television, as well. People spend upwards of $80 a month for broadcast TV.

There's only a handful of good shows, and they spend the rest of their time watching Fox News or something else. So you know, I think that quantity is important. And you guys were just talking about Walmart. Nobody goes into Walmart expecting to buy premium brands and, you know, spend a ton of money. They go in for quantity. And that's what Netflix is. They're the Walmart of streaming video, and they've got everything.

- Michael, so what does that make YouTube then? I mean, people kind of ignore that story because they're folded under Alphabet. They're not their own standalone company, but they get a lot of subscribers, a lot of watchers, a lot of revenue for way less cost for the content itself. Are they like the tough steak of-- I don't know, what does that make them?

MICHAEL PACHTER: I mean, the content is largely free. It's user-generated content. That's a different model. You know, so I think that that's like comparing TikTok to a record label, to Spotify. Yes, you can entertain yourself on TikTok and listen to amateurs perform. And one out of 500 is going to be phenomenal. Or you can listen to your favorite artists on Spotify and pay more. So YouTube is to Netflix what TikTok is to Spotify, sure, of course.

There's room for all of this stuff. We like user-generated content. And you get people like Justin Bieber, who emerged from YouTube. That's great, but he's one out of, whatever, 10 million people who posted music videos on YouTube who made it.

- Right, of course, with everything, you're always competing with only two eyeballs, so very much a lot of movement in the media space. Michael Pachter, Wedbush equity research analyst, thanks again for spending time this morning, appreciate it.