| On Nov. 30, 2011, Wedbush Securities analyst Michael Pachter said Netflix was a broken company, and he saw no way to fix it. Pachter advised his clients to sell the stock, and estimated its value at $6 a share. Many analysts shared Pachter's skepticism at the time. Netflix had just split its DVD-by-mail business from its streaming business, an unpopular move that amounted to a 60% price increase for its customers. Hundreds of thousands of people had canceled their accounts. Netflix proved its skeptics wrong again and again, and this week it hit two new milestones. It blew past 200 million subscribers and said it would no longer need to borrow money. The company now generates enough cash to pay for all its TV shows and movies without taking on more debt. And yet, Pachter has maintained a sell rating the entire time, earning a reputation as Wall Street's most prominent Netflix bear. For those unfamiliar with him, he is an outspoken user of Twitter, a key analyst in the video game industry and a fan of single malt scotch. Anyone who followed Pachter's advice missed out on one of the greatest stock market runs in modern history, a return of more than 2,000% over the last decade. Netflix is now worth 250 billion and trades at about $565 a share. Had you invested just $1,000 when Pachter said to sell, you'd have turned that into more than $20,000. Pachter is not alone in his skepticism. Needham & Co's Laura Martin has said Netflix must include advertising, or will lose millions of customers. But he is one of the most vocal critics. Unlike many analysts, Pachter is actually willing to criticize companies he covers -- and willing to admit when he's wrong. In a note published this week, he wrote he has been "consistently wrong" about Netflix. In light of Netflix's biggest year ever, I called Pachter to discuss what he got wrong and why he's still betting against the company. He started with the simplest mistake of all: "I never thought they'd get to 200 million subscribers," he said. "I thought they were close to saturated in the U.S. Even this quarter, 850,000 more is impressive. They just keep adding people." Pachter made three key miscalculations that are common among many of Netflix's skeptics. - He thought big media companies would do a better job of protecting the cable TV business. Companies like NBCUniversal, CBS, Viacom and A+E should have starved Netflix of their programming. Instead, they couldn't turn down the checks and kept licensing their biggest hits. When their shows drew new customers to Netflix and away from cable, they responded by creating services of their own, further undercutting cable.
- When those media companies did pull their shows, Pachter didn't think Netflix would be good enough at making programs of its own. But Netflix has had no problem churning out popular shows. Its critics are quick to note that it produces a lot of crap, but that's a foolish argument. It makes shows that are entertaining and good enough. "At $14, you're not getting ripped off," he says.
- With Netflix's massive output of new shows, he thought the service would always need to spend more, and never stop burning cash. The Netflix-has-too-much-debt argument was always based on Netflix's growth slowing. But it was able to rein in spending – aided by the pandemic – before its growth slowed: "They turned positive free cash flow and didn't lose anybody. They grew revenue and had the astute move of raising prices during all this. Suddenly, they are much healthier than I thought."
Pachter reserves most of the blame for traditional media companies that let Netflix eat their lunch. "With respect, I think they are stupid," he says. "They are all public and have to answer to board members, and have to explain why Netflix is eating their lunch. They sold everything to Netflix, and they got addicted to the earnings stream. To pull back is expensive." The only executive in all of media who has been able to control his board is Disney Executive Chairman Bob Iger. Pachter believes Netflix will remain the dominant player in streaming for years, commanding 30% of the market. And yet, he still has a sell rating. He's increased his price target all the way from $6 in 2011 to more than $300 today. But that's about $200 below where they are trading. Why not finally give in to Netflix? He's trapped by a valuation model that treats Netflix like a mature company and assumes it can only grow so much. Based on his model, the company would need to double or triple its revenue to get to his free cash flow target, which means the company would need to raise prices by $5 and double its user base. To get to the valuation that his peers have suggested, they would need to triple the user base. Despite all of Netflix's success and despite proving him wrong time and time again, Pachter is still unwilling to believe the company can reach 600 million users. "There are only two billion households," he says. "There's just not that many people that can subscribe to Netflix." After chatting for half an hour, I had to ask him if he's ever gotten in trouble for being so wrong about Netflix. Pachter says he's not worried one bit. Lots of people have been wrong about Netflix, and it's just one of a few dozen companies that he covers. "I'm so handsomely compensated for all the things I'm right about," he says. "Netflix is like the mole on Cindy Crawford." -- Lucas Shaw The best of Screentime (and other stuff) | 
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