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Netflix's content pipeline 'has dried up,' analyst argues

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Netflix posted mixed earnings for the second quarter. Wedbush Securities Managing Director Michael Pachter joins Yahoo Finance Live to discuss.

Video Transcript

- Yeah, and of course, Zack, Netflix has been touting their global growth for some time. But you look at the subscriber add numbers dropping in North America. It certainly does raise questions about whether, in fact, it is about increased competition. Although co-CEOs Ted Sarandos and Reed Hastings seem to sort of brush that off to say, well, it's not necessarily what the competitors are doing.

For another voice in the conversation, let's bring in Michael Pachter. He is Wedbush Securities Managing Director. Michael, we know you have strong opinions about the gaming side. I'm going to wait for that just a bit. But let's talk about the global subscriber adds here because that's a number that a lot of investors have been focused on.

Things slowing down here in North America. How much of that you think is just the result of the demand being pulled forward last year during the pandemic? How much of that are you looking at and saying, there's a little trouble on the horizon?

MICHAEL PACHTER: You know, I actually think it's all because demand was pulled forward. But you know, as they pulled that demand forward last year, I think that they got that much closer to market saturation. And they love to talk about global numbers, and 800 million internet households. And they're at 209 million, so plenty of headroom.

But the truth is, you know, there's only about 85 million households in the US that have internet. And they're already at over 60 million of those. So you know, the right question is, are they going to get that last 40%? Maybe. Sorry, 40%, 25 million. Maybe. But I don't think it's going to be a fast path, and that's where competition kicks in.

Competition plays two ways. One, for wallet, because you're subscribing to multiple services. But probably far more importantly and overlooked by my competitors is competition for content. And Disney and Fox aren't giving anything to Netflix ever again. Universal is not. Paramount is not.

So I think it's really going to be tough for these guys competing against Disney, Peacock, and Paramount Plus when those guys are holding back all their content. HBO remains a question. I think AT&T has no idea what they're doing. We'll see how the Discovery partnership works out. They might get desperate and maybe license some older content. But I really think the content pipeline is dried up for Netflix.

- Yeah, that had always been a concern, particularly when we look at how much money they were spending and how much cash they were burning, and negative free cash flow. It they kind of got a little bit disrupted in the pandemic because their production costs came down for the quarter, though, and you saw that negative 175 million of free cash flow versus positive 899 million. Of course, those comps, as I said, tough when you're thinking about the pandemic and production costs there.

But moving forward, they're still expecting full year to be about break even when it comes to cash flow. I mean, it's an improvement based on this trajectory we've seen for Netflix. So I suppose that would be the counter to some of what you're saying around competition costs and production costs for Netflix. I mean, is that the case? Or is it just kind of a head fake based on the fact that we did see production fall off a cliff in the pandemic?

MICHAEL PACHTER: No, 100%, you're spot on. Cash flow is improving. I think that these guys can be a profitable company and generate cash consistently for the next 10, 20, 30 years. They're not going away. It's a good company.

The open question is, what are they worth? And my $362 target is giving them credit for a billion of free cash flow growth each year for the next 10, discounting it back at a 5% free cash flow yield, and I can only get to 362. So the guys with $600 price targets are making stuff up as they go.

I mean, you cannot say Netflix is less risky than a Treasury bill. It just doesn't make any sense to me.

- Michael, let's talk about the gaming strategy. The company made it pretty clear they see this as a new content category, sort of comparing it to the expansion they made into original films and animation, as well as unscripted TV. If the issue is trying to keep the subscribers you have, bring on additional subscribers at a time of saturation, is gaming going to be it for Netflix?

MICHAEL PACHTER: You know, I think Zack actually summed it up when he talked about being excited about "Stranger Things." Netflix has been doing streaming for 14 years, and Zack mentioned one show that's a big hit that they own. There aren't very many that are good. There are many that are hits, but not very many that are good. And those IPs don't lend themselves to games.

As bad as I am on Netflix, I'm probably equally really good on games. This is a tough business. I've covered eight public companies-- gaming companies-- that have gone bankrupt in the last 20 years. It is really tough. And Netflix shrugs it off and says, well, we're going to go into mobile.

Take a look at Activision, EA, Take-Two, Ubisoft, and Nintendo, and tell me what their mobile prowess is. They've all bought their way in. None of them has created a mobile game that's been successful until Activision created Call of Duty just a year and a half ago. So no, this is a really, really, really hard business.

And I think the bigger question is, how do you get a game on the TV? Let's say you get it there because Amazon's figured out how to do it. How do you control the game? Not with your remote control. You're going to need a game controller that talks to every TV, every Fire TV stick, Roku stick, Chromecast. That technological challenge is nearly impossible. I do not see Netflix surmounting that challenge.

- They were also flexing-- I mean, you know, that is one that is going to have to be answered moving forward. We talked about how kind of the mobile emphasis there might be something that could get them around that, if people are going to take them up on the offer to play mobile games. But outside of that, they did flex kind of their technological advances when it comes to streaming.

And that is something that I do think maybe gets overlooked when it comes to Netflix and the way that they have made it easier relative to some other platforms out there. Maybe Peacock. Maybe a Hulu. When you look at of how the process works and how, you know, the next show might load, what do you make of maybe how Netflix has been able to make those advancements to steal-- content aside-- maybe flex the experience of streaming over their competitors?

MICHAEL PACHTER: You know, they actually don't power the streaming technology. They use AWS and the others. In gaming, the only company outside of Microsoft, Amazon, and Google that's tried to stream games is Sony. They spent over a billion dollars on Gaikai and OnLive, and they announced a couple of years ago they're going to partner with Microsoft Azure to deliver their streaming initiatives.

So you've got the three biggest cloud providers in the world who are struggling to actually make this work. Microsoft is succeeding. The other two guys are so far flops. And here's Netflix's, audacious little Netflix, popping up and saying, we can do it better. Good luck. It is really, really hard. They don't have the expertise internally to pull it off. And I think that they're-- some would say ambitious. I would say audacious.

- We'll see if they do, in fact, pull it off. Michael, it's always good to talk to you. Michael Pachter, Wedbush Securities Managing Director.