Netflix is dealing with one of its biggest challenges in the past decade: attracting investors to a seemingly broken growth story.
"Once Netflix’s subscriber base began to contract, investors stopped viewing the firm as a growth stock," Citi Analyst Jason Bazinet wrote in a note to clients on Tuesday. "But, given the lack of free cash flow, value investors are unsure how to assess the firm. As such, Netflix’s equity does not have a natural investor base."
Bazinet noted that Netflix had a "simple algorithm" for "over a decade" — basically to spend more on content and add subscribers — and that is no longer the case as content consumers escape their homes with the COVID-19 pandemic easing.
Netflix's 200,000 drop in new users for the first quarter came as a surprise to Wall Street. Analysts were looking for a slowdown but still positive growth in subscriptions in the first three months of 2022.
Citi's Bazinet — who maintained a buy rating on Netflix shares at these much lower levels — shared two options for Netflix to reignite its stock and profits. Netflix is modeling for subscribers to decline by 2 million in the fiscal second quarter while consensus analysts are looking for a gain of 2.4 million.
Shares of Netflix have been severely penalized for the slowdown: the stock has crashed nearly 70% year to date.
Citi's Bazinet — who maintained a buy rating on Netflix shares at these much lower levels —shared two options for Netflix to reignite its stock and profits.
"During 1Q22 earnings, Netflix identified two opportunities to resume top line growth: 1) reduce account sharing, and 2) introduce an ad tier," Bazinet explained. "We built a demand curve for U.S. users and it suggests Netflix may have difficulty generating incremental free cash flow from reduced account sharing. But, ad revenue from YouTube [owned by Alphabet] and SVOD rivals suggests Netflix can generate ad revenue of $10 per month from U.S. users and $3 per month from non-US users (or $5, on average, globally)."
An ad tier in the U.S. and internationally could send a jolt to Netflix's free cash flow line says Bazinet, which would be welcomed news to investors as this is a very closely metric on the streaming giant.
By Bazinet's calculations, a U.S. ad tier could add $900 million to $3.6 billion of incremental free cash flow to Netflix. Internationally, that range clocks in at $800 million to $3.1 billion.
"Right now, Netflix is no longer a growth stock," Bazinet stated. "And, value investors are less than keen to step in given the lack of free cash flow. To attract value investors, we believe Netflix needs to narrow the gap between free cash flow and net income. It’s about $5 billion a year."