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Analysts say Netflix's streaming dominance outweighs risk of churn

Despite navigating a streaming market riddled with pitfalls, Netflix Inc. remains on sure footing ahead of its third-quarter earnings release on Oct. 20, according to analysts.

Unlike many names in the media and entertainment industry, Netflix has benefited greatly during pandemic-roiled 2020, and the month leading up to the earnings release was no exception. Netflix added almost 13% to its market capitalization, while other competing companies like The Walt Disney Co., Comcast Corp. and ViacomCBS Inc. lost ground.

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One driver of Netflix's share price in recent weeks has been speculation around whether the company will raise prices, especially in its international markets.

Jefferies Equity Research analyst Alex Giaimo said in late September that he expected the company to initiate a price hike in the foreseeable future, which could add $500 million to $1 billion in 2021 revenue despite increased churn.

The analyst based his analysis of international consumer appetite for increased prices on a survey his firm conducted among Netflix subscribers in India, which showed only 10% would cancel if Netflix raised prices and about 64% would pay an additional $2.34 or more per month, the highest increase included in the survey.

Giaimo reiterated an "overweight" rating on the stock and increased his price target to $570.

Around the same time, however, Netflix also found itself at the center of a controversy that weighed on subscriber retention. The company promoted French film "Cuties," which was controversial for its depiction of sexualization of children. The backlash registered as a swelling cancellation rate among subscribers, and a Texas grand jury got involved, indicting Netflix for promoting content that allegedly includes "lewd" portrayals of a minor.

Truist Securities analyst Matthew Thornton said in an Oct. 15 research note that while churn increased in the third quarter "in large part due to the controversy around 'Cuties,'" he believes this spike in churn was "fairly short lived."

He cited Google Trends data that showed a spike in internet searches for the phrase "cancel Netflix" that peaked in mid-September and resolved by the end of the month.

Thornton expects Netflix to beat its own guidance for third-quarter net additions of 2.5 million subscribers. Applying an app-download model to estimate paid net member additions, Thornton believes Netflix will report 4.4 million additions for the quarter.

The analyst reiterated his "buy" rating and $560 price target for Netflix in an Oct. 15 earnings note.

But Pivotal Research's Jeffrey Wlodarczak on Oct. 7 said Netflix's 2.5 million additions guidance "appears reasonable."

The low number, though, does not concern him, given Netflix's dominant position in the subscription video-on-demand market. Wlodarczak said his "thesis on NFLX would remain unchanged even if they were to report a flat quarterly subscriber result ... given the massive beat in 1H, the difficulty of forecasting 3Q and ... favorable broad SVOD trends."

Netflix added 15.8 million net subscribers in the first quarter of 2020, followed by 10.1 million net additions in the second quarter.

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Wlodarczak, who bumped up his price target for the company to $650 and maintained a "buy" rating, said Netflix will likely remain "the dominant global SVOD player for the foreseeable future."

At least one analyst, however, was not quite as bullish, warning that Netflix's subscriber growth could vanish if it is not able to refresh its content on a regular basis.

"We expect people to continue to consume content for the balance of the year at an elevated rate. While a high level of consumption is desirable, it drives a need to constantly replenish the content consumed," Wedbush Securities analyst Michael Pachter said in an Oct. 16 Netflix earnings note.

Between the challenge of creating content during the pandemic and the increased competition from streaming services like Disney's Disney+ and Comcast's Peacock, Pachter believes Netflix will have a hard time maintaining subscriber interest. "We suspect that this phenomenon has already begun and led to the company's lackluster guidance for Q3 net additions."

Pachter had an "underperform" rating on the company and a $220 price target, warning that the demand headwinds and the company's continued cash burn could lead to devaluation.

Netflix closed Oct. 19 at $530.72.