Needham Downgrades Netflix (NASDAQ: NFLX), Issues Stark Warning

It was just a week ago when news of Citi's disastrous choice struck Netflix (NASDAQ: NFLX) investors like a thunderbolt: either lose 5% of market value by giving up a whole string of viewers or lose 15% of market value by ramping up spending on content. That news was bad enough, but recent word from Needham sank another nail in the coffin, downgrading to the equivalent of a “sell” rating and issuing another disastrous choice: add a new subscriber tier or lose millions of customers.

A Guaranteed Losing Bet?

Needham's assertion presents Netflix with another terrible choice: it must either add a new subscriber tier, one supported by advertising in a similar fashion to Hulu and others or risk losing a bundle of subscribers measured in the millions. Four million, in fact, as projected by Needham analyst Laura Martin.

Essentially, Martin points out a matter that is by now familiar to streaming viewers and streaming market watchers alike: there are a whole lot of competitors out there and the number is growing. Start with established rivals like Hulu, Amazon Prime Video and others and throw in the corporate-backed upstarts like CBS All Access, Peacock, Disney+ and others and the market looks so jam-full of options that competing on pricing will become necessary to survive.

Martin goes on to note that Netflix really can't sustain decreased revenues, so in order to effectively compete, Martin suggests adding a new, lower-priced tier that turns to advertiser support to draw in the users. This would go against Netflix's long-established strategy of eschewing advertisers, but the lack of that low-price option will drive some subscribers off, by Martin's estimation. Further, Martin notes that international expansion alone won't make up for the lack, thanks to the significant increase in profitability domestic users represent.

Needham's projections didn't include a price target; however, the company asserts that the stock is attractive at $260, significantly down from its current level of $297.62 as of this writing.

Jumping at Shadows?

While it might seem like the analysis market is turning against Netflix in large numbers, right now, any kind of serious calamity is a minority-held view. We know about Citi's downgrades, and recently, word from KeyBanc Capital Markets suggested that Netflix could have trouble keeping its subscriber counts up in the face of growing competition. But those two, and Needham, make up a body of just seven sell-equivalent ratings that Bloomberg data could locate. Fully 10 companies boast “hold” ratings on the stock, Bloomberg data further notes, and 29 have “buy” recommendations.

Indeed, our own projections suggest Netflix may have found a bottom back in mid-October, though other reports suggest that Netflix would have a pall over it for most of 2019, with 26 downgrades seen in the last 90 days.

Ad Support Fixes the Wrong Problem

Let's leave aside the issue of whether or not Netflix is a good buy or hold and instead check on Needham's central proposition: that Netflix should add a cheaper, ad-supported tier to help shore up the company's interests. Under normal circumstances, this would seem like a bad idea: if there's one thing retail market watchers know, it's that the only winner in a price war is the consumer. Sure, pricing tactics have their place—just ask Walmart (NYSE: WMT) who famously used price strategies to fend off competitors—but in a field like streaming, it's likely better to compete on being the place that has content you won't see anywhere else.

This leaves Netflix at a serious disadvantage; the corporate-backed upstarts like Disney+ don't especially need to be concerned about revenue. Most of the upstarts' streaming services are sideshow efforts, contributing another income stream to operations. Netflix counts on streaming, so to cut prices in a bid to draw customers may damage its cash flow irreparably. Netflix's odds of survival without other people's content is minimal; its movie library is already 40% smaller than it was five years ago, according to Streaming Observer figures, and some project Netflix may ultimately go all-original.

While a cheaper tier may help in the short-term, Netflix is under the gun in terms of keeping its customer base in the face of growing competition. With content providers cutting out middlemen like Netflix to offer their own material to their own customers, it's not clear just how helpful a new tier can really be.