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Netflix expected to shake off new streaming competition in Q4'19

Investors and analysts have been split on Netflix Inc.'s prospects in the face of increased competition and negative cash flow, but as the company prepares to report its results for the last quarter of 2019, few expect to see any significant miss.

The company's quarterly results come on the heels of high-profile streaming announcements from competitors such as The Walt Disney Co. and AT&T Inc.'s WarnerMedia. Disney launched its over-the-top platform Disney+ in November 2019 and has already added about 40 million subscribers, according to reports citing research firm Sensor Tower. Netflix in its third-quarter 2019 commentary said the new competition could weigh on its fourth quarter, and it lowered its full-year guidance. But Wedbush digital media analyst Michael Pachter expects any impact to be minimal.

"I think early adopters [of Disney+] are going to subscribe to both," he said.

The first round of sign-ups to Disney+ will come from higher-income households, consumers that can afford to carry both services, he said. Some of those that do have to shave their entertainment bills to add Disney+ will potentially trim cable first.

Netflix shares were at $338.16 in afternoon trading Jan. 17. The average equity analyst price target was $361.21 as of Jan 16 market close, according to S&P Global Market Intelligence data.

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Pachter, for his part, does question Netflix's high valuation, arguing that while competition may not impact the company's fourth-quarter 2019 result, it will be a material headwind by the end of 2020 — not just for subscription-video market share, but also for the price of content. Analysts with "buy" ratings on the stock and price targets over $400 are implying that Netflix will improve its cash flow by about $1 billion to $1.5 billion per year for the next 10 years, the analyst said. "I don't think that's remotely possible," he said, defending his "sell" rating on the stock.

Among those with a bullish outlook on the stock is Goldman Sachs internet analyst Heath Terry, who reiterated a "buy" rating and a $450 price target. Terry argued that Netflix's strong fourth-quarter 2019 release slate will drive outperformance on paid net membership additions. The company in October 2019 guided to 7.6 million net additions, but Terry said he believes it could launch well past that to 9.7 million additions.

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Pivotal Research Group analyst Jeffrey Wlodarczak, who covers entertainment and interactive subscription services, agreed in an early January note that reiterated his firm's "buy" rating on the stock. He argued that the direct-to-consumer market will fill out not at the expense of Netflix, but at the expense of traditional pay TV subscribers, a trend that could actually benefit Netflix as consumers put together custom digital bundles.

Wlodarczak said Netflix has too great a head start to easily fall to newer OTT entrants, a comment echoed by Bruce Tuchman. Tuchman is a board member of digital video research group Parrot Analytics, a tech and media investor and a former executive at AMC Networks Inc.

Netflix in the third quarter of 2019 had about 61.3% of the global demand share of digital originals, followed distantly by Inc.'s Prime Video, which had about 12.4% of original content demand share, according to Parrot Analytics.

"It's not so easy to just replicate," Tuchman said in an interview.

Further, 2019 marked the fifth year in a row Netflix has grown its footprint at the Academy Awards, garnering 24 Oscar nominations in January compared to 15 in the prior year. That is partly due to higher investments in theatrical film production and distribution, a strategy that Pachter at Wedbush doubts, but Tuchman believes will pay off.

"It's an expensive strategy," Tuchman said, pointing to high-cost films like "The Irishman," which carried a production budget of about $140 million. But the investor believes the company is making returns in marketing, subscriber interest and industry recognition. "It's a smart investment."

Pachter noted that while a high-profile film may drive subscriptions in the short term, it may not be enough to retain a subscriber over the long term, unlike original series that tend to hold viewer attention longer and bring viewers back with each subsequent season. He also said it is highly unlikely Netflix will make up the budget on "The Irishman" with the number of subscribers that film alone will generate.

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