A Wall Street analyst figured out the real price Netflix should charge customers — and he says it would destroy the company’s growth (NFLX)

Reed Hastings

Wedbush analyst Michael Pachter on Tuesday reiterated his "underperform" rating on Netflix's shares.
His bearish view comes despite the company's earnings report Monday, in which it reported that it added a million more subscribers in the first quarter than analysts expected.
Pachter is concerned about Netflix's cash burn, and thinks the company can't turn that around and post significantly positive cash flow without raising prices to the point that it curtails growth.

When it comes to Netflix, Michael Pachter remains a bear — even after seeing the company posted standout quarterly results on Monday.

Long skeptical of the streaming video company's business model, and of its ability to generate meaningful returns for investors, the Wedbush analyst on Tuesday reiterated his underperform rating on Netflix's shares. He did up his price target to $125 a share from $110, but that only underlines his pessimism; in recent trading, Netflix shares were trading at $336.92, up $29.14 a share, or about 9%.

In explaining his rating, Pachter pointed to Netflix's ongoing cash burn: The company had a net outflow of about $284 million in its latest quarter, stemming from its operations, and its investments in equipment and DVDs for its legacy business. The company said Monday it expects to continue burning through cash for the "several more years," Pacther noted. Realistically, the company won't be able to staunch the bleeding unless it dramatically raises prices, a move that would likely severely crimp its growth, he said.

"Until we see evidence that it can successfully deliver positive free cash flow, we advise investors to seek more compelling investment opportunities," Pachter said in a research note. "We believe that Netflix’s valuation is unwarranted."

Pachter's bearish note followed the company's earnings report Monday. While Netflix's revenue and profits were in-line with Wall Street's expectations, it added 7.4 million subscribers in the first quarter, about a million more than analysts had forecast. Many of Pachter's colleagues on the Street used the company's results to issue bullish reports on the company and raise their price targets to the stock's current level or beyond.

Even Pachter was impressed with that kind of growth.

"Netflix is absolutely delivering on its growth goals," Pachter said. He continued, saying the company "is clearly doing something right."

But the company is essentially boosting its subscriber growth by underpricing its service, he said. While the company posts a profit on its income statement, that accounting ledger only takes into account a portion of the money it's spending on producing and licensing movies and television shows. Once you factor in the actual money Netflix is sending out the door, the company's cash flow is deeply in the red and getting worse.

Last year, the company's free cash flow — which takes into account operating expenses and investments in property and equipment and other long-lived assets — was in the red by $2 billion. This year, the company expects a $3 to $4 billion outflow.

In order to it breakeven from a cash flow perspective, Netflix would have to raise its prices to about $15 a month globally, Pachter estimated. Right now, it charges $11 a month in the US and about $9 internationally. To be a significantly profitable business, it would have to charge about $20 a month.

At that level, Netflix's growth rate would almost certainly slow to a crawl, given the growing number of competitors, all of which offer their services at significantly lower prices.

"In conclusion, we aren’t yet ready to drink the Netflix Kool-Aid," Pachter said.

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