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Netflix is ‘battling behemoths’ with stronger content production: Analyst

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Michael Pachter, Wedbush Securities Managing Director, joins Yahoo Finance Live to discuss his thesis on Netflix as the platform's subscriber growth slows and it faces stiff competition in the fragmented streaming market.

Video Transcript

- Yeah. Let's break down these results further with our first guest for the hour week. Michael Pachter, Wedbush Securities Managing Director, equity research. Michael, you know, this stock, specifically Netflix, has been a darling during the pandemic. And there's been a lot of concern. Yes, they had a lot of momentum over the last two years. Was there a lot of pull forward? What do you make of the stock reaction?

MICHAEL PACHTER: I think it's appropriate. And you know, as much as I respect Reed Hastings' intellect-- he's just not a stupid man-- he was incredibly disingenuous in that clip you just showed, because he ignored the three things that are driving the share price down. One is that Netflix is a lot bigger than they were in the last 12 years, and they're approaching market saturation, particularly in high GDP countries. Second is the competition from Hulu and Amazon Prime was maybe 50 million subscribers, you know, five years ago. It's over 200 million now between HBO Max, and Peacock, and Hulu, and Paramount Plus, and Disney Plus. So you know, subscribers are peeling off.

And then, the third thing, which really matters, is each of these services is keeping its own content exclusive to its own platform. So Netflix used to have Disney content, not-- just a couple of years ago. No more, no Disney, no Fox, no NBC Universal, no Paramount, you know, ViacomCBS. So the idea that Netflix can keep growing without the content it historically has had access to in a market that is fragmented and chasing the same wallets and with Netflix already penetrated in all above-median-income households in the West, it's-- it was inevitable they were going to stop growing. I've been wrong for 10 years. I'm going to take my victory lap now. I'm right finally after 10 years of-- of downgrade.

- Michael, would love to know, what kind of spend profile you think that this enters Netflix into? As you mentioned, on the content side, this means that if there is that risk of content rolling off, so that some of those other platforms can continue to take some of that back and the equity that comes along with those titles, where that means Netflix is going to have to continue to lean in to try and create the next "Stranger Things" or just continue to create some of the popular series, "Ozark," "Bridgerton," and what-- what you may have there.

MICHAEL PACHTER: Well, clearly, the-- everybody's competing for the same content. Netflix has done a great job with owned originals, "Ozark" not being one of them. Coming out today, by the way. That's owned by Media Rights Capital "Bridgerton" is owned but you know they're paying Shonda Rhimes something like $300 million to produce that. So it's highly likely that that is an unprofitable series they have to keep finding the "Squid Games." And they're doing a great job. They really are. I think the original content's great. I think their licensed content's great.

The problem is they're probably 75% licensed still. And each licensed property has to be renewed every year. So "Ozark," season four coming out tonight, guess-- or so I guess it's already out-- they have to pay for seasons one, two, and three again. And HBO doesn't have that problem. All their shows are original. And Disney, same. So I think Netflix's cost disadvantage in competing for a shrinking pool of independent content is bad. I don't think they're really any better than Disney or Warner Brothers at making original content. And in fact, HBO content is significantly better at least on Metacritic terms. So you know, I think it's just a tough road. I think these guys are battling behemoths who are better at producing content than they are.

- Michael, as you noted, you've got an underperform rating on the stock. When you think about the moves today, we're getting closer to that 12-month price target you have of $342 a share. What would it take for you to change that rating? What do you want to see?

MICHAEL PACHTER: Oh, I mean, my target's sincere. So if the stock gets to, you know, within-- I think our-- our ruling-- our rules here are within 10%. So it literally could drop another $10 or so. And I-- I have the right to upgrade. I actually want to see probably one more quarter. But if the stock melts down and goes to $250, of course. Of course, I would upgrade. You know, I don't know how permanent this is. There are a lot of people, you know, cult members who have, you know, drunk the Kool-Aid. And they decided they just love Netflix at any price. So my guess is it'll probably rebound as soon as the market turns green and probably go back to $450. And I-- I have no interest in raising my price target until I see what their growth profile and their cash profile is.

- And considering that cash and the spend that's necessary, as we were mentioning a moment ago, on that licensing and even on the production side, you know, where does this set up for one of the other major categories for Netflix, too, that at least we've thought they would do better about getting into. And that's on the gaming front. Yet, we still don't have a ton to go off of there. What are you going to be watching for most closely as we continue to see what types of breadcrumbs they give us on gaming and their ambitions therein?

MICHAEL PACHTER: I really am watching for how many years it takes before they give up and write the whole thing off. Disney tried to do gaming three different times in the last 20 years and shut it down three times. The only media company that's been successful in gaming is Warner Brothers. And of course, they got purchased by AT&T. And-- And that unit is rumored to be for sale. It's hard. Gaming is really hard. And Netflix isn't going about it right. The guy they hired is an accomplished video game guy, but he last produced a game 20 years ago. And you know, I haven't seen him cobbling together a team that's going to churn out quality content. So I think they're chasing this the wrong way.

I think they should have been involved in buying Zynga. I think they should have been involved in buying Activision. And they just don't seem to have any interest. They don't want to make a big statement. They want to grow slowly. I will comment-- I will-- I'm confident they will grow really, really slowly. So the question is just, when do they realize that they can't get there, and they have to give up?

- You just mentioned two names that Microsoft has now gone after. We have-- can't let you go without asking about the big deal this week of Microsoft acquiring Activision Blizzard. As somebody who's been following the gaming space, how big of a shift does this represent?

MICHAEL PACHTER: You know, look at that Activision share price, $81. That's the risk ARB's telling you that they have low confidence that this deal will be approved by regulators at 95. So you're getting a 15% discount on a deal that's likely to close within a year. That's a pretty good return. And-- And you know, Microsoft was out with a tweet yesterday saying they're going to support the PlayStation platform and that "Call of Duty" will be on the PlayStation. That's preemptive. That's to tell regulators, we're not trying to put Sony out of business.

Think of Microsoft buying Activision the same way you would think of Disney buying Fox. They want more content for the streaming service, and they can keep it off Netflix by doing so. So Microsoft wants more content for Game Pass. And by buying Activision Blizzard, they keep it off of the, you know, upcoming Sony streaming platform. That's smart. It's legal. And regulators aren't going to block that as long as they continue to support the platforms that Activision supported in the past. So I think this is a great combination. I'm disappointed to see it happen, because it takes one of my-- my favorite stocks out of my coverage universe. But it's actually the right thing for Microsoft to do. And Activision gets all of its sexual harassment issues behind it pretty quickly.

- Michael, always good to get your take here. Michael Pachter, Wedbush Securities Managing Director of equity research.

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