Netflix (NFLX) held its fourth-quarter earnings call on Tuesday, where both co-CEOs spoke about all aspects of the business. Most notably the deal with TKO (TKO) to become the streaming home of WWE RAW, starting at the beginning of next year. Shares of the company were up 10% in pre-market trading Wednesday morning, but one analyst does not feel as positive about Netflix despite some of the buzz behind it.
Citi Managing Director Jason Bazinet joins Yahoo Finance to discuss why he remains neutral on Netflix and what investors should keep in mind when considering to invest in the company.
On what concerns Bazinet, he broke down certain elements of Citi's recent downgrade on the stock: "We think content spending has to go up next year. They were explicitly asked on the call if they should step off the accelerator on content spend and generate more free cash, and they said absolutely not. We want to spend more as long as we continue to grow. So I think that part of our thesis is still intact."
Click here to watch the full interview on the Yahoo Finance YouTube page or you can watch this full episode of Yahoo Finance Live here.
TED SARANDOS: And now with this great storytelling-- with the events itself are the storytelling of the WWE-- so this is a proven formula for us that we're excited to jump into. This is sports entertainment, very close to our core. The deal is long term. We're super excited about it.
SEANA SMITH: So Sarandos very excited about what this could mean-- but despite all of this, and the excitement, the optimism, our next guest-- maintaining his neutral rating on the stock. Let's talk about it. We want to bring in Jason Bazinet. He's Citi's managing director joining us now.
So Jason, it seems like Netflix is almost firing on all cylinders, an extremely strong quarter here for the company, lots to be excited about, especially when you tie-in the recent deal that they have with WWE. Why are you staying on the sidelines?
JASON BAZINET: Well, our neutral rating had three elements to it. We were a little bit nervous about the fourth quarter revenues of this year. We'll see if that's still true, given this very strong number.
The second one is we think content spending has to go up next year. And they were explicitly asked on the call if they should step off the accelerator on content spend, generate more free cash. And they said absolutely not. We want to spend more as long as we continue to grow. So I think that part of our thesis is still intact.
The third element of our downgrade is really the potential that they do M&A. And it was very interesting on the call yesterday, the CFO mentioned for the first time that they're under levered relative to their ideal capital structure. So it sort of hints to financial firepower to go potentially do a deal above and beyond the $7 billion of cash that they have on the balance sheet.
BRAD SMITH: What is the characteristic of a deal that would make sense for them to do?
JASON BAZINET: Well, they've dabbled, of course, in mobile games. They've also spoken publicly about the lack of intellectual property that exists within Netflix. So we've always thought a AAA game publisher, like a Take-Two that has strong IP like GTA and has a big strong mobile portfolio with Zynga would make a lot of sense, because you'd kill two birds with one stone. You'd get the mobile games and you'd get the IP.
SEANA SMITH: Jason, when it comes to the fact that when we hear from the executives in the call that they're not interested in linear assets, not exactly a massive surprise there. But when you talk about maybe some of the pressure that the stock could face if they don't live up to some of these expectations or the guidance or what some of your colleagues on the Street are looking for, what do you think that downside risk then could look like here for Netflix if they do continue to spend at a higher rate than maybe what's being priced in?
JASON BAZINET: Yeah, the Street goes back and forth. Sometimes they look at earnings, sometimes they look at cash flow. I mean, the most common framing that I hear is sort of if you rolled forward one year and you had $20 of earnings, some investors say, well, I'd put a 20 multiple on that if things falter. And that would get you $400. Other investors say, well, $20 a share, I'd pay a 30 multiple for that, and then you get $600 a share. And so you can see at $540, where we are today, it doesn't strike me as particularly compelling.
BRAD SMITH: Jason, when you talk about that free cash flow, some of it seems like it's going to come back to the pricing power here. And they did acknowledge this on the call last night. We do have a brief clip of them talking about where some of those fees could move a little bit higher or moderate higher for customers. Let's take a listen real quick.
GREG PETERS: We will continue to then monitor other countries and try and assess when we've delivered enough additional entertainment value. We look at engagement, retention, acquisition as the signals there, so that we can go back to members and ask them to pay a bit more to keep that positive flywheel going, and we can invest in more great film series and games for those members.
BRAD SMITH: So what type of pricing power from this point would you need to see from Netflix in order to change your type of positioning currently on it?
JASON BAZINET: Yeah, I don't-- I don't have a real any qualms with the value consumers are getting with the level of engagement. So I think we'll probably see mid-single digit pricing growth across all of the countries on average.
BRAD SMITH: How does that translate into some of the subscriber growth as well? Do you believe that that moderates lower in terms of the year over year percentage or kind of stays the same?
JASON BAZINET: Yeah, so our forecast has about 10% top line growth. So it's about five units of volume, five units of price to get to the 10% growth. The reason the stock is reacting so positively is the real debate among the buy side is not so much whether they have pricing power. The real question is, what is the magnitude and duration of the two main subscriber growth metrics, which is the ad tier crackdown-- password sharing crackdown and the ad tier, right?
And so when they guide to eight or nine million subs, and they do 13, that's telling the market, hey, this has a lot more legs to it, could be higher magnitude than we thought.
