While the fear of the coronavirus spreading any further has gripped society, the majority of industries and the markets, it is an unavoidable fact that some can use the outbreak to its advantage. Take for instance, hand sanitizer companies, or the biotechs searching for a vaccine against the disease. Or companies that could benefit from people staying in, consuming large quantities of entertainment. Netflix (NFLX), for example. Or so you would think. But, not so, argues Needham’s Laura Martin who tagged Netflix shares with a bearish Underperform rating. (To watch Martin’s track record, click here)
In contrast to the perceived notion that Netflix will benefit from people staying in and consuming more entertainment, the 5-star analyst contends the virus will have the opposite effect, impacting negatively on Netflix for several reasons. Let’s take a look at the arguments:
More Views Does Not Equate More Revenue
Simply put, additional viewing hours by subscribers does not benefit Netflix financially. This is because subscribers pay a fixed amount each month, regardless of the amount of content consumed. In the US, this amounts to $9-$16 a month.
“We have been arguing that NFLX needs a $5-$7/month price subsidized by $5-$7/month of ads to compete with new streaming entrants at $5-$7/month,” Martin says. Additionally, the analyst argues, an ad-driven tier with more viewing hours would let shareholders “participate in revenue upside.”
International Sales Under Pressure
Netflix has benefited from rapid international growth, but the virus’s spread is impacting the economy and jobs market in many countries. Martin cites Italy as an example, where the whole country has been quarantined, and is, therefore, out of work and not getting paid. Since NFLX is a luxury, the analyst argues, international churn will rise, and revenue growth will slow until the virus fades.
Negative Free Cash Flow and Junk Bonds
Martin’s final piece of the argument concerns the company’s cash flow. Before the advent of the virus, Martin estimated Netflix’s layout on content in 2020 would amount to between $17-$18 billion, resulting in negative FCF of roughly $3 billion. Should the company’s revenue decrease, it is still committed to provide the bulk of the content. Worse still, if sales drop in Latin America, APAC or the EU, a highly likely scenario right now, the negative free cash flow could be further impacted, as the combined regions amount to approximately 60% of Netflix’s estimated revenue in 2020.
This could lead to an alarming chain of events, according to Martin: “At 12/31/19, NFLX had $5B of cash on its balance sheet, implying it might be forced to raise capital before 12/31/20, depending on global demand. At a BB- credit rating, NFLX is a Junk Bond. Bonds designated ‘Junk Bonds’ by the rating agencies have higher risks than investment grade debt. Also, their cost of capital typically rises faster in periods of uncertainty. If the equity and/or debt markets close for any extended period, this could represent a non-trivial problem for NFLX. One of the benchmarks that lenders look for when they price NFLX’s debt is how much of a cushion they have based on the market value of NFLX’s equity. This cushion falls with NFLX’s share price.”
So, what does the Street make of Netflix’s prospects over the next twelve months? 22 Buys, 7 Holds and 3 Sells coalesce into a Moderate Buy consensus rating. The average price target is $380 and implies possible upside of nearly 9% from Wednesday’s closing price. (See Netflix stock analysis on TipRanks)