Netflix (NFLX) will be yet another company dented by the global coronavirus outbreak, according to Needham analyst Laura Martin.
In a note Tuesday, Martin reiterated her Underperform rating on shares of Netflix. By Martin’s estimation, beliefs that the streamer will be insulated from the outbreak’s impact have been overblown, as the company faces the threat of losing international subscribers and the ability to stem its existing cash burn as the virus spreads.
To date, the company’s stock remained largely resilient even as concerns over COVID-19 dragged the broader market lower. Many latched onto the view that Netflix would benefit from having subscribers at home to use the service as they shirked public entertainment amid the outbreak.
That perspective has translated into a stock that rose nearly 7% in February, outperforming against the S&P 500’s 8.4% decline.
But having more people at home to binge more hours of Netflix won’t necessarily translate into higher revenue for the company, Martin pointed out.
“NFLX charges a fixed price of $9-$16/month in the U.S., regardless of how many hours are watched,” Martin said. “More hours viewed by existing subs are not monetized by NFLX.”
Netflix does not offer an ad-driven tier and has so far declined to take on an advertising-based business model, despite broad investor speculation as more competitors join the fray. That decision prevents Netflix from capitalizing on any upside from increased viewership that could arise as social distancing increases with the coronavirus outbreak, Martin said.
And given that Netflix was already saturated in the U.S. at 61 million domestic subscribers as of December 31, “it’s unlikely that COVID-19 adds new U.S. subs,” Martin said.
Netflix ‘is a luxury’
The coronavirus outbreak also threatens to cap growth in Netflix’s international subscriber base, Martin said. International paid users climbed by about 30% at the end of 2019 to 106 million, with Europe, the Middle East and Africa (EMEA) segment constituting the highest number of subscribers outside of North America.
“Italy just quarantined its entire country implying millions of travel employees are not going to work or get paid, and travel globally has declined precipitously,” Martin said. “Since NFLX is a luxury, we assume international churn will rise and offshore revenue growth will slow until COVID-19 retreats.”
Threat of slowing subscriber growth aside, Netflix’s heavy content spending also presents a vulnerability and could amplify the company’s negative free cash flow if and when revenue falls. The company spent $15 billion in creating content in 2019, Netflix said in January, and Needham’s Martin said she expects that number will climb to as much as $18 billion this year.
“Even if NFLX’s revenue falls, its content commitments are largely fixed,” Martin said.
Netflix’s free cash flow (FCF) in 2019 had been negative $3.3 billion, which the company said at the time would be “the peak in our annual FCF deficit.” But Netflix’s FCF profile could be “materially worse” if revenue falls in Asia, Europe, or Latin America, which together comprise more than half of Netflix’s estimated 2020 revenue, Martin said.
And while the high-yield bond market has been Netflix’s spigot of choice for cash infusions, that source could become more difficult to tap if Netflix’s subscriber and revenue growth slows and translates into a lower stock price, she added.
“One of the benchmarks that lenders look for when they price NFLX’s debt is how much of a cushion they have based on the market value of NFLX’s equity,’ Martin said. “This cushion falls with NFLX’s share price.”
Martin has maintained an Underperform rating on Netflix since December 2019. The stock has 29 Buy and Buy-rating equivalents, 8 Holds and 7 Sells, according to Bloomberg data.
Emily McCormick is a reporter for Yahoo Finance. Follow her on Twitter: @emily_mcck
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