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As its stock drops 30 percent in early trading and analysts speculate about the streamer's password sharing crackdown, some are adding pointedly that the company isn't one of their top picks anymore.
Downgrades, stock price cuts and colorful language – that was Wall Street’s reaction to Netflix’s surprise first-quarter loss of 200,000 subscribers and bigger second-quarter user drop forecast of an additional 2 million users.
At least a couple of analysts also said a day after the streaming giant’s earnings that Netflix is not their favorite stock idea anymore. And much discussion in reports focused on new Netflix initiatives, such as a crackdown on password sharing and a planned lower-priced advertising-supported subscription tier. In early trading, the stock was down 30 percent at $244.01.
“Tudunzo,” Wells Fargo analyst Steven Cahall entitled his Wednesday note in reference to Netflix’s famous “tudum” start-up sound and the fact that he sees the Netflix story as “dunzo for now.” He downgraded the stock from “overweight” to “equal weight” and slashed his stock price target from $600 to $300. “Negative sub growth and investments to reaccelerate revenues are the nail in the Netflix narrative coffin, in our view,” he argued. “The new outlook is clear as mud.”
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Pivotal Research Group’s Jeff Wlodarczak, meanwhile, highlighted the company’s “shocking” results and guidance in cutting the stock all the way from “buy” to “sell.” He also lowered his price target from $550 to $235.
“From a stock perspective in a period of rising rates pushing back profitability materially is likely to not be welcomed by the investment community,” Wlodarczak highlighted. “This overhang will likely be exacerbated by investor concerns that: 1) company will have sub losses in the first half of ’22 and streaming appears nearly fully penetrated globally post-COVID (making this about converting pirates or taking share or price increases); 2) the increasing effects of competition as competitors launch their services globally some of which again may not be focused on piracy or even profitability in the case of Apple or Amazon; 3) heightened investment in growth would appear to up the expense hurdles for all the players in streaming leading to even further potential cost inflation (offset partially by even higher barriers to entry); and 4) against this backdrop the major streaming players are arguably not cheap.”
“Reality Bites,” Guggenheim analyst Michael Morris noted in the headline of his report. While he continues to rate Netflix shares a “buy,” he cut his price target from $555 to $350 while highlighting: “We are also removing Netflix as our best idea” after “a big quarter for surprises.”
Comments from top executives, including co-CEOs Reed Hastings and Ted Sarandos, also featured prominently in his and others’ reports. “While management sees a ‘creative excellence’ and new-monetization-fueled re-acceleration of topline growth over the next 18 months, we have significantly reduced our outlook for member and financial growth over the next decade, meaningfully reducing our target valuation,” Morris explained.
BMO Capital Markets analyst Daniel Salmon, who has an “outperform” rating on Netflix, cut his stock price target from $640 to $405 “to reflect lower free cash flow estimates, a higher risk-free rate and equity risk premium and lower terminal multiple driven by slower perpetual growth assumption.” And he added that Netflix is now “no longer [our] top pick owing to near-term headwinds.” His new “pecking order” for big digital stocks is: Amazon, Netflix, Alphabet/Google.
The BMO expert also noted the streaming giant’s changed focus. “We think management completed the narrative transition by conceding to advertising and mechanically impairing the member/subscriber metric through disclosure of 100 million ‘password sharers.’ And with the stock trading after-hours at 13 times our new 2024 adjusted earnings before interest, taxes, depreciation and amortization estimate (versus 23 percent growth), the growth (investor) to GARP (growth at a reasonable price) transition should be over,” Salmon wrote.
Cowen analyst John Blackledge maintained his “outperform” rating on Netflix shares, but reduced his price target from $590 to $325. “Given the results and guide, we lowered our near and long-term forecast,” Blackledge wrote. “Management does not expect revenue growth to re-accelerate until potentially ’24 or perhaps sooner, depending on the success, timing and scaling of the new advertising tier and conversion of password-sharing households. Despite the lower outlook, Netflix expects to maintain 19-20 percent operating margin until revenue re-accelerates. Netflix also expects to be free cash flow positive in ’22 and to grow from there.”
Addressing the user shortfall with a first-quarter loss of 200,000 subscribers, the Cowen expert concluded it was “primarily due to declines in mature markets,” explaining: “Management noted that the Russia pause (due to suspending its service there amid the war in Ukraine) and high existing penetration coupled with password sharing, increased competition and macro issues all factored into” the guidance of a 2 million user drop in the current second quarter. “Asia-Pacific first-quarter net adds were in line with our expectations, as Asia-Pacific recorded 1.09 million net adds (versus our 1.09 million forecast). Meanwhile, net adds in U.S./Canada, Europe/Middle East/North Africa and Latin America were lower than expected.”
Wall Street’s initial view on Netflix’s advertising tier plans
Analysts spent much time discussing Netflix’s plans to launch an ad-supported lower-priced subscriber tier down the line. “We have added an initial advertising contribution (preliminarily modeled as net revenue) beginning in late 2023 and reaching a $4 billion profit contribution by 2030,” wrote Guggenheim’s Morris. “For context, by our estimates, Hulu generated just over $3 billion in advertising revenue last year with around 88 percent of subscribers taking the ad-supported option. While we don’t expect Netflix to have the same mix, we highlight that it had roughly double the share (6.4 percent) of total U.S. TV Time versus Hulu (3.0 percent) in February 2022 per Nielsen. In addition, Netflix is a global service versus Hulu’s U.S.-based presence.”
BMO Capital Markets’ Salmon also shared his thoughts on the ad strategy. “Netflix is unlikely to reinvent the wheel, and investors should expect an initial focus on branding versus direct response, with engagement into established private marketplace programmatic pipes,” he argued and noted “read-through beneficiaries.” Netflix’s expected branding focus makes TradeDesk an “odds-on favorite to be (the) first demand partner,” he argued. A “legacy relationship with Roku makes it a likely partner candidate, too.” Online ad tech firms Magnite and Innovid could also benefit, he argued.
Wells Fargo’s Cahall argued that the U.S. and Canada “represents this biggest AVOD opportunity, as we think about 70-80 percent of Hulu subs subscribe to the ad-supported tier versus the ad-free tier.” He added: “The ad-supported subs generate about $8.50 per month in ad ARPU per our Disney model, which complements the $6.99 per month in subscription ARPU for the ad-supported service. This makes the ad-supported product more lucrative as ad-free Hulu is $12.99 per month.”
What will Netflix look for? “Presumably, Netflix hopes to accomplish both net add and revenue improvements from a future ad tier,” Cahall suggested. “Assuming a similar long-term ad average revenue per user (ARPU) for Netflix domestically, it could look to price the subscription component of the ad-supported tier at around $10 per month, or an approximately 50 percent discount. Given the scale of viewership, we think ad ARPU at or above Hulu is a reasonable medium-term assumption. The same evolution is likely to happen in international markets as well.”
But Cahall warned: “What’s impossible to know is when advertising will roll out, what pricing will look, how many subscription subs will switch to ad-supported and how many incremental subs will come from having access to an ostensibly cheaper, ad-supported tier. Given these unknowns, both domestically and internationally, we currently do not model advertising as meaningfully accretive to subs or revenues.”
Wall Street observers also discussed their latest takes on Netflix’s emerging push against password sharing.
“Password sharing remains an ongoing problem for all streaming media services,” said PP Foresight analyst Paolo Pescatore. “Clamping down might help, but there might not be a one-size fits all solution. There will be disgruntled subscribers who may cancel altogether. Netflix will have to experiment with different price tiers to cater for diverse audiences. In the first instance, a low-cost AVOD offering might help convert freeloaders.”
Cahall noted that password sharing “now reads as a reaction to a tougher marketplace.” He added: “It has always been an opportunity, but we think it got here a little faster than what investors had hoped for, i.e. sub growth is slowing earlier than planned. We therefore think the narrative implication is offsetting to potentially incremental subs and revenues, for now. This could certainly change over time.”
With management signaling that its data indicates there are some 100 million users that are borrowing passwords, including around 30 million in the U.S. and Canada, “this means that there should be a meaningful opportunity to bring some under the revenue tent,” the analyst concluded.
Morris also summarized his takeaways from the password sharing data shared by management. “This means effective total addressable market penetration (based on broadband accounts) is as much as 50 percent higher than penetration based on reported member levels. Management continues to expand on tests (currently rolled out in three markets in Latin America) to monetize additional users through ‘paid sharing features,’ which should begin to more meaningfully contribute to per-account revenue (not membership levels) beginning in 2023.”
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