Netflix (NFLX): Why Investors Should Analyze Free Cash Flow

Wedbush's Michael Pachter still stands by the bears here, not looking for positive free cash flow from NFLX for many years- but he acknowledges positive subscriber trends.


Netflix, Inc. (NASDAQ:NFLX) delivered a strong first quarter earnings show that even the only bear betting against the video streaming giant on the Street is out boosting his target expectations. Shares are on a 7% surge this morning and Wedbush analyst Michael Pachter cannot ignore a second quarter guide he accepts as “bullish,” pointing to sustained positive trends for the company.

Therefore, the analyst maintains an Underperform rating on NFLX stock and lifts his price target from $110 to $125, which still implies a 62% downside from current levels. (To watch Pachter’s track record, click here)

That said, Pachter warns, “we don’t expect positive FCF for several years.” This kind of negative free cash flow simply makes discounted cash flow (DCF) valuation, where Netflix’s stock value would be assessed based on its forecasted future cash flows “impossible,” writes the analyst. For this tech player to reap profits at a level warranted by the price of its shares, Netflix needs to experience monster growth and meaningfully boost prices. However, Pachter has yet to see proof that Netflix is able to achieve positive free cash flow- and until he does, his bearish recommendation in a nutshell is to take the gamble elsewhere: “we advise investors to seek more compelling investment opportunities.”

Pacther forecasts years of cash burn ahead for the giant: “We expect Netflix to burn cash to fund content acquisition for many years, notwithstanding the fact that it has increased price three times while cash burn continues to grow. International profits may remain elusive due to competition for content and subs, and the price increases could cause a deceleration in subscriber growth.”

For the first quarter, Netflix impressed with not only a beat here but likewise on a stellar second quarter outlook. The giant yielded $3.701 billion in revenue against the analyst’s projection of $3.700 billion and the Street’s $3.690 billion- and the company’s own guide calling for just $3.686 billion. EPS of $0.64 may have underwhelmed Pachter’s estimate of $0.65, but NFLX did meet the Street’s $0.64 forecast and beat out its own guide of $0.63.

Subscriber momentum kept roaring in the first quarter, with Netflix adding 1.96 million net domestic subscribers to its empire, trouncing the analyst’s expectations for 1.50 million and the guide that called for a mere 1.45 million. This almost is as impressive as Netflix’s 1.98 million added the quarter before, and way ahead of the 1.42 million seen this time last year. The international front brought another beat to the table for the giant, with Netflix adding 5.46 million net subscribers against the analyst’s expectations for 5.25 million and far surpassing its own guide of 4.90 million. This number lands below the 6.36 million seen last quarter, but soars far ahead of the 3.53 million added this time last year. Though Pachter is bearish, he recognizes this performance is a robust one for the giant: “Quarterly net subscriber additions were the second highest in company history, trailing only Q4:17.”

For the second quarter, Netflix angles for 6.20 million in total net subscriber additions, setting expectations to reach $3.934 billion in revenue, $469 million in operating income, $358 million in net income, and $0.79 in EPS. In comparison, the analyst had prior estimates looking for 4.75 million in total net sub adds, $3.909 billion in revenue, $338 billion in operating income, $250 million in net income, and $0.55 in EPS. In other words, Netflix hit a big home run here, likewise beating out the Street’s prior estimates hovering around $3.893 billion in revenue, $389 million in operating income, $288 million in net income, and $0.65 in EPS. Based on the quarterly subscriber growth guide, the analyst expects a record high performance of second quarter net additions this year, beating out last year’s number of 5.20 million.

With $10.99 as a price tag for domestic services and a rough average circling $9 abroad, the analyst cannot ignore that the company is set to keep burning cash. Bulls may argue leverage could rise from content spending, especially with growth seen in Netflix’s revenue base, to put it bluntly, the analyst disagrees.

“Given that the vast majority of Netflix’s content (including the bulk of its ‘originals’) is licensed; so long as that is true, Netflix’s content spend is likely to grow in lock step with its revenue growth. In our view, this is the reason that cash burn has increased each of the last four years, and is likely the reason that cash burn will continue for the ‘next several years’, as the company has stated,” Pachter concludes.

TipRanks exhibits NFLX as stock that has magnetized a fair amount of bulls on Wall Street- with a sole bear running for the hills: Pachter. Out of 36 analysts polled in the last 3 months, 22 are bullish on NFLX stock, 13 remain sidelined, while 1 is bearish on the stock. With a return potential of nearly 7%, the stock’s consensus target price stands at $329.26.