Netflix Needs A Lower-Cost Subscription Tier, Needham Says In Downgrade

Walt Disney Co's DIS Disney+ and Hulu, Apple Inc.'s AAPL Apple+, CBS Corporation's VIAC All Access and Comcast Corporation's CMCSA Peacock are sure making life difficult for industry original Netflix Inc NFLX.

The Rating

Needham analyst Laura Martin downgraded Netflix to Underperform.

The Thesis

Netflix charges between $9 and $16 per month for its service compared to rival rates between $5 and $7. Martin expects Netflix to cede 4 million premium U.S. subscriptions in 2020 as viewers defect to more affordable alternatives.

“Since NFLX’s balance sheet cannot withstand larger cash losses (our view), we think that a new $5-$7/month pricing tier, subsidized with ads, is the best answer for NFLX,” the analyst wrote in a report.

Netflix isn’t likely to take Martin’s advice. Management has insistently rejected advertising. As a result, Martin expects a drop in subscriptions, which will weigh on the firm’s valuation both directly and indirectly.

Stock reactions to past earnings reports suggest a close correlation between valuation and subscription growth. Additionally, because U.S. subscriptions contribute three times more profit than international subscriptions, a decline in domestic metrics could cut free cash flow and push management to pursue more debt or public equity, which could pressure share price.

The subscription decline also messes with Netflix’s strategic spending. “NFLX customer acquisition costs escalate rapidly when NFLX tries to buy back lapsed subs, which takes capital away from content investment or adds to NFLX’s negative FCF gap,” Martin wrote.

Needham would become more constructive on Netflix around $260 per share.