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How to Fix Netflix

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One disgruntled analyst charts a path to recovery.

Wedbush Securities' Michael Pachter has been perhaps Netflix's chief critic among a chorus of those questioning the company's recent moves. The analyst sparked a mini-feud in late November by calling Netflix's decision to raise $400 million via debt and a stock deal "bad to the point of desperation" and sizing up the company's outlook starkly: "Their revenues are insufficient to provide enough cash to pay for their planned content acquisition costs." Netflix even shot back with a statement saying the company "has no cash or liquidity needs" and is simply raising capital because "it's always nice to have more money than you need." As Pachter has no trouble asking pointed questions of execs, The Hollywood Reporter turned the tables and pointedly asked him what Netflix CEO Reed Hastings should do to get the company back on track.

THE HOLLYWOOD REPORTER: What is Netflix doing wrong, and how specifically can it right the ship? 

Michael Pachter: I think that any 5-year-old could tell you that if you have to raise prices because of streaming-content costs, you should raise the price for the streaming customer. Netflix instead chose to raise prices on the DVD customer, leaving the streaming-only plan at $7.99. People who saw their hybrid charge go from $9.99 to $15.98 are the ones who are quitting, not the guys at $7.99.

THR: Netflix is optimistic that it can return to aggressive growth. Can it accomplish this goal, and what is standing in its way?

Pachter: The company's statements about how it expects a strong rebound in "domestic streaming net additions" shows how out of touch it is. For each hybrid customer who quits at $15.98, it needs to attract two streaming-only customers at $7.99; for each hybrid customer who trades down to streaming-only, it needs to add another streaming customer. Their net additions may rise, but their revenues could continue to decline.

THR: What is the biggest challenge the company should address right now? 

Pachter: Netflix faces a dilemma: In the past, it was valued based upon its subscriber growth, and it received a high valuation because it was able to grow subscribers at a high rate while continually delivering profit growth and margin expansion. When the company blew up, its profits declined and its subscriber growth slowed to a crawl. The company has chosen to pursue subscriber growth at all costs. It is willing to forgo profits altogether and was forced to raise capital at what I consider unfavorable rates. The dilemma: It can continue to grow subscribers and no longer be able to deliver profits, or it can pursue profitability but be unable to grow subscribers as rapidly as in the past.

THR: So what should the company do? 

Pachter: I think that executives have to decide what they want to be when they grow up. If they keep current pricing, they have to choose  low growth and decent profits, or low profits and decent growth. If they try to deliver growth and profits, they are destined to fail.

THR: Do you believe this will happen?

Pachter: I think that they don't get it, and they will have to hit bottom before they recognize and acknowledge that the model is broken.