Netflix under pressure after UBS downgrade on valuation concerns

Shares of Netflix ended lower on Tuesday after UBS analysts led by Eric Sheridan downgraded the stock to neutral from buy. Sheridan notes that while the streaming company’s long-term narratives remain intact, the benefits of strong trends have been priced in. The Final Round panel discusses the call.

Video Transcript

MYLES UDLAND: All right. It's time now for our "Call of the Day," and today we are talking about UBS's downgrade on shares of Netflix. The firm taking stock to neutral. That is from buy.

They still have a price target $535 per share, and the stock basically trading right there at a record high just a few days ago. Off 1.2% today. But, Seana Smith, I find this note quite interesting, because they're downgrading the stock, but I kind of view it as UBS saying, actually, everything's great with Netflix. It's just the stock has gone so far so quickly, we can't justify recommending it as a buy-rated stock at this point.

SEANA SMITH: Yeah. I'm happy you have that take on it, because that's exactly my conclusion from this note, because obviously, from a valuation standpoint, sure, this argument makes a lot of sense. This is a stock that has risen more than 60% so far this year. It's a clear outperformer in the market not only this year, but going back for the past several years.

And obviously, at the price that it's currently trading at right now, it's by no means cheap. It's trading at, what, just around 10 times its forward sales, which obviously means that this is a stock that is pretty expensive. And that's pretty much the argument that UBS is making in this note. And what they talk about specifically, already being priced into the stock.

They talk about the strong trends. They're priced in. And that it sees tougher comps ahead. And that tougher comps is specifically talking about their subscriber numbers. We know Netflix posted very strong subscriber numbers in the first quarter, expected to post another strong quarter here this week when we get the earnings in a couple of days.

So it's obviously going to be a little bit tough when you compare future quarters back to the first quarter and the second quarter of this year. So I think this is strictly a valuation call. The price target that UBS has on the stock is still slightly or slightly higher than where it's trading today. Their price target is at $535.

So overall, they're pretty positive on Netflix. And I think the bull-bear dynamic on the stock that we're seeing play out with Netflix, a lot of it has to do strictly with valuation. Not so much a business model, but really where the stock is trading today, because if you remember last week-- or maybe it was two weeks ago-- we talked about a note that we got from Cowen, and that centered around the pricing of Netflix's subscriptions, and they discussed the pricing power that the stock has-- or that the company has going forward.

And they were pointing to a recent survey that the company did, suggesting that Netflix's pricing power is rising amid the COVID pandemic. So I think that that's something that investors are keeping in mind. We're not necessarily expecting a price hike here within the next quarter or two, but as we look ahead into 2021 and into 2022, that could be something that could potentially really move the stock here in, I guess, the medium term.

MELODY HAHM: And I think Eric Sheridan at UBS is just thirsty for ideas right now, right? I mean, we were on the show yesterday, exactly 24 hours ago, talking about Goldman's call, that Disney+ and Viacom are gonna be the winners here. To be honest, yeah, it's not a fresh take. It's not interesting, new commentary.

It's more so like, you know, when you're having a feedback review with your manager, and your manager's like, everything's fine. There's just one thing. You should smile more. Or there's this one thing. You forgot to put a period-- you know, something very kind of frivolous and arbitrary like that. And that's how I read this note.

I actually found RBC analyst Mark Mahaney's points in a separate note-- really interesting-- where he just laid out how many new originals are flooding the zone during this time. According to his analysis, about 60 new originals were uploaded in July. That's about two a day. And that far surpasses what we're seeing from the likes of Disney, which is eight, HBO Max, seven, four from Amazon, and three from Hulu.

And basically, UBS's take is that there's-- there's no more good news that come-- that can come out of this. It's almost like the-- the thesis is right there. We already know that Netflix has been the first mover, has had a huge gap between itself and the lot even with Peacock from NBC coming out. There's nothing, you know, exciting to really look forward to, especially in the streaming space, as we've sort of dissected all of the other competitors-- quote, unquote, "competitors"-- including the likes of Quibi, Peacock, and HBO Max.

DAN ROBERTS: Yeah. And, guys, as Seana mentioned, I mean, the issue here is really just how high the stock has gotten. The note mentions that, you know, we'd like to see potential subscriber volatility and competition better reflected in the stock price. Well, OK. But those have been the two hurdles for Netflix for a long time now, right?

And every time that a new streaming option launches, you say, mm, more competition for Netflix. Well, OK. It would be interesting to-- to theorize, if we want to play this game, when there might be a time when there's something to criticize Netflix for. Now, for a while, as everyone used to note, it was profitability, right? And it was the-- the rampant spending.

And every year when the new figure came out, Netflix expects to spend TK billion dollars on original content this year, people would gasp. The spending is so high. Well-- and then everyone would say, well, they can raise prices. But there hasn't yet been a moment that I can recall recently where we've seen Netflix say, spend big to acquire a certain series, or some kind of action, something kind of new that has been criticized as a misstep, whereas, you know, you look at Apple TV+. And wow, they're spending this much on these three original shows, and two of the three bombed completely.

You know, no one watched "See." That's for sure. No one watched "Dickinson." It hasn't happened yet for Netflix. But people have criticized Disney a little bit.

You saw a little bit of jawing that $75 million looks so expensive to spend on "Hamilton." I think we can already say that was a smart purchase. That was just fine. It looks like it boosted service.

We'll see when we get the new numbers for Disney+. But yeah, it would be-- it would be more interesting when and if down the road we might see a note that says, you know, here's the strategic move Netflix made that now looks like it may have been a little bit of a stumble. Haven't-- haven't seen it.

MYLES UDLAND: Yeah. I think-- and, you know, Dan, just to-- to, you know, kind of wrap up that specific point, the Netflix strategy is that if one bombs, it doesn't matter. Next man up. You know, the problem with Apple is they said, here are our five shows. It's like, well, three of them stink so that's not a very good batting average.

Netflix just got into "Unsolved Mysteries." I don't know if anyone out there has done that as well. You should all watch the UFO episode. It's hard to tell if it's a real thing or if it's fake. But another example of a thing that comes up on Netflix, and you're like, this is great.

DAN ROBERTS: It is just like VC, right? I mean, it's like--

MYLES UDLAND: Yeah. Exactly.

DAN ROBERTS: It's like Andreeson Horowitz. Now, soft, eh. You know, it hasn't gone so well since some of its biggest bets haven't worked out. But you can have six of the companies you invest in bomb if the seventh is the next Facebook.

MYLES UDLAND: Yep. Certainly a company to watch. Earnings on Thursday. We'll have them for you live here on "The Final Round" coming out right around 4:00 o'clock eastern.