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Bearish stock run pressures Netflix to show Q3 subscriber growth after Q2's miss

As Netflix Inc. prepares to report its third-quarter financial results Oct. 16 amid unusually bearish market sentiment on the stock, analysts said the company faces pressure to show that its big expansion and content investments are paying off.

Interest in overall subscriber growth remains high as the company hopes to meet or beat its guidance for 5.0 million net membership additions after missing on that metric last quarter. While Netflix's stock historically has enjoyed as much as a double-digit bump in the trading day after it reports earnings, its largest post-earnings declines in recent years have tracked with missing subscriber guidance. After the company reported a subscriber miss in the second quarter of this year, for example, its stock lost 5.2% in value the day following the release.

The markets already are on a bearish run amid volatile trading of Netflix and several other high-profile technology stocks. Netflix has shed about 9.2% of its equity value in October, outpacing a 6.8% drop in the Nasdaq and a 5% drop in the S&P 500 index for the month as of Oct. 12. Prior to this year, Netflix shares historically had shown mostly gains leading up to the company's earnings report. Despite the more bearish market sentiment leading into the third-quarter report, Wall Street analysts remain largely optimistic about what Netflix's subscriber growth will show.

SunTrust Robinson Humphrey analyst Matthew Thornton expects Netflix's international subscriber additions alone to break the 5 million mark, well above the 4.4 million guidance issued by the company. Thornton also expects Netflix to report a modest beat on its guidance for 650,000 domestic net additions.

Moody's analyst Neil Begley said that while Netflix's quarterly subscriber numbers have come in "consistently lumpy" in the past, the annual trends are smoother and show a solid growth trajectory. However, he and other analysts also are looking beyond subscriber movement, which has long been a primary driver for Netflix's stock, to questions about the company's broader financial profile.

"Does [subscriber] growth outpace the growth in their spend on programming, now that they're done launching new markets? … That's really the question," Begley said in an interview.

Netflix since early 2016 has financed a massive international expansion largely with debt, and now the company is banking on the success of those new markets. Netflix's total debt hit a peak of $8.34 billion in the second quarter. Its revenue for the quarter was $3.91 billion and net income came to $384.3 million. That left the company with negative $518.2 million in cash flow from operating activities by the end of the second quarter.

The weight of negative cash flow is partly responsible for the "underperform" rating and low price target from Wedbush Securities analyst Michael Pachter.

"[Free cash flow] has gotten worse for five consecutive years and is expected to worsen this year and next. There is zero visibility into a reversal to positive FCF, and the company has repeatedly warned investors to expect negative FCF for the foreseeable future," Pachter said in an interview.

Also behind Pachter's bearish outlook is the increase in competition. Media conglomerates like Walt Disney Co. and AT&T Inc. are consolidating content under their owned properties and pulling some shows and movies off of Netflix's platforms in the process. The demand for new content also is driving up prices for the talent and production, Pachter said, leaving Netflix in an increasingly perilous financial and competitive position.

Pachter's $125 price target was the lowest for Netflix tracked by S&P Capital IQ. The mean price target among 40 analysts was $377.43. Netflix shares closed trading on Oct. 12 at $339.56.

For his part, Begley at Moody's was bullish on the long-term position for Netflix. He compared the company and its competitors to the television networks that grew as the media became mainstream in the second half of the 20th century.

"They're all going to have substantial video-on-demand services," Begley said of content companies. "Over the longer term, they will be replacing the networks we've known historically."

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