One of the most stubborn (by his own admission) Netflix bears, Wedbush Securities analyst Michael Pachter, has issued a landmark upgrade on the streaming giant’s stock.
While he still doesn’t consider it a clear “buy,” Pachter raised his rating to “neutral” from “underperform,” with a 12-month price target of $342. Amid widespread gains today for many stocks, Netflix shares were up 4% in early trading, at $356.71.
Acknowledging the momentousness of the change in the title of his note to clients — “Hell Freezes Over” — Pachter didn’t offer any hosannas or describe any sort of epiphany. Rather, he merely conceded that the company does actually have something of an edge in the streaming contest. “Netflix’s first mover advantage and large subscriber base provides the company with a nearly insurmountable competitive advantage over its streaming peers,” the analyst wrote.
For more than a decade, Pachter had recommended that clients sell Netflix shares, costing them a roughly 1,700% return over that span. In an article in Bloomberg last year, the analyst gamely conceded the inaccuracy of his call in November 2011 urging investors to dump the stock, which he predicted would fall to $6. “I never thought they’d get to 200 million subscribers,” he told the news outlet. “I thought they were close to saturated in the U.S. … They just keep adding people.”
Despite the upgrade, Pachter still sees a significant vulnerability in Netflix’s adherence to the binge-release pattern for its series. Other streaming services have largely stuck to more gradual rollouts, with a goal of limiting “churn,” or the percentage of subscribers who cancel in a given period. Netflix historically has had churn in the low-single-digits, the envy of an industry where the average churn is more like 35%. Pachter sees the salad days coming to an end unless the company rethinks how it parcels out programming.
“We think that slowing subscriber growth reflects a flaw in Netflix’s business model,” Pachter wrote. “Prior to its success with original content, Netflix subscribers were offered full seasons of television series that had already appeared on broadcast networks. The ‘water cooler’ moment discussing last night’s episode was a distant memory by the time the series made its way to Netflix, and CEO Reed Hastings and his team invented the concept of ‘binge’ watching by dumping all available episodes of licensed second window series at once.”
Recent wobbles in the company’s subscription growth prove this is a liability, in Pachter’s view. “Theoretically, a subscriber who watches only a handful of Netflix originals can join for six months and quit for six months,” he wrote, “and if this becomes the norm, churn will increase and net subscriber additions will slow to a crawl.”
The analyst said he opted to upgrade the stock “primarily on valuation.” Netflix shares “have dropped precipitously, from a high of $691 in mid-November down to our
price target of $342 on March 8,” he noted.
While Pachter has technically left the bear camp, there are still a few hard-core skeptics on the Netflix. Needham’s Laura Martin reiterated her “underperform” rating on its shares in a note to clients last month. Her main complaint is the company’s unwillingness to incorporate advertising, which she sees as a way for it to reinvigorate subscriber growth with lower-cost subscription plans. Netflix “can NOT win the ‘streaming wars’ given its current strategy,” Martin wrote.
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