Blain’s Morning Porridge – April 26th 2019 – The Jenga Moment

Blain’s Morning Porridge – April 26th 2019

“You’re an excellent judge of horse-flesh Trooper Tyree. You proved that when you stole my horse.”

That was an interesting week… What did we learn? No surprise at the deepening crisis in Argentina or a comic elected president in Ukraine. Headlines this morning are about the lack of vol in currency markets, worries about Italian debt, and what did Putin promise Kim. Stock markets hit new highs as they continue to lap up any good news and discount negativity… How many column inches did Boeing get after withholding guidance due to the deepening uncertainty about the fix on the B-737 Max or the fact its received zero orders since the second crash? Almost none. Facebook’s privacy breach fine got swept under by the strong results, and the stock rocketed higher….

Traditionally Friday is my rant day….

Nothing surprises me that Facebook stock soared on the back of its strong results. But maybe it should? For months analysts, media and politicians have been fulminating about how the “Surveillance Capitalism” Stocks have pillaged our private data, changed the world and our behaviours through their algorithms, and how social media is damaging us all in ways we barely understand. But when the acid test comes? A call between a bad behaviour fine, or increased revenue? Of course we lap up the stock because its advertising revenue is better than expected, discount the regulatory threats, and forget what we were complaining about last week.

\Is it complacency, greed or just plain stupidity that makes market behave this way? What’s not to like about rising stock prices?

I worry. The world is so fundamentally changed from anything Ben Graham wrote in “The Intelligent Investor”. The Disruptive Tech companies that have dominated these last 10 years are now maturing. Some are proven. Others continue to overturn conventional investment wisdom and thrive.

Which of these stocks will trigger the Jenga moment? 

Let’s start with some analyst buy/sell recommendation ratios:

  • Tesla – 66% Sell Rec
  • Facebook – 80% Buy Rec
  • Netflix – 66% Buy Rec
  • Lyft – 60% Buy Rec (Uber is coming…)

Facebook is what Facebook is.. Forget everything and buy it for its ad revenue… until the next thing comes along or folk just stop using it…  The obviously vulnerable one is Tesla: $700 mm Q1 loss, likely to face a massive cash call as it burns through cash faster than anticipated, run by man who seems to think the market will thank him for asking for yet another $2 bln. Did you know Tesla is being outsold by Audi and Jag electric models in Europe by a factor of around 5 to 1? I’ve driven the Jag and was mightily unimpressed. But, ranting about Tesla would be seal clubbing…  We’ve got the Uber float coming on the back of Lyft. They are taxi companies – just like We Work is just a property play. Do they justify their valuations?
Lets pick on Netflix.. Fresh from a successful $2 bln raid on the Junk bond market this week, Netflix remains a stock market darling.  
But first, those of us of a certain age will remember Betamax vs VHS, and the video store. Did you know there is still a single Blockbuster video store open? Its in Oregon and survives mainly on tourists. Back in 1989 Blockbuster was opening a video rental store somewhere in the world every 17 hours.
Netflix certainly does not want to be Blockbuster. It’s over two years since I first wrote about the non-sustainability of Netflix’s subscriber acquisition cost – the amount it pays in content spend to attract subscribers. I questioned whether it could survive long enough to keep paying $12 bln a year for content to attract 35 mm new subscribers per annum, while its also raised $12 bln in debt. Generating increasing negative cashflow and raising debt aren’t generally positive investment themes.
But perhaps Netflix has turned the corner? With nearly 150mm subscribers, it’s now approaching critical mass. Let’s assume each subscriber pays $100 per annum, (they say its higher, but there are 6 month free offers and its cheaper in some countries), then Netflix is moving into positive cash flow (if you discount its debt), and being able-ish to cover that $12 bln annual new content spend.
Gosh? Does that mean it will start paying a dividend or even taxes? Of course not. If Netflix was paying taxes, they’d be doing it wrong. And I suspect its real problem is its reached critical mass just in time for everyone else to want its business niche.
Now the talk is all about how Netflix is going to stand up to competition in the content streaming world. The analysis and media talk about Disney “posing the most serious threat to Netflix’s dominance”.
They are right. Disney is 95 years old, the most valuable entertainment brand, owner of theme-parks, film rights, media, studios and lots of other stuff. It will shortly launch a $7 per month streaming service with all its content from the Mouse, innumerable Princesses, Star Wars and the Avengers.. plus lots of content you didn’t even know was Disney. Disney isn’t the company that replaced Blockbuster. It’s a brand. It makes Content people want to pay for. The three likely biggest movie releases of the year: Frozen II, Star Wars 9 and Avengers are all Disney!
Netflix was a disruptive idea around streaming programmes. Now its trying to become a content brand. Its sole credential for succeeding is its ability to pay up for the best talent…
Disney is clearly a threat to Netflix. Apparently, surveys show about 14% of Netflix subscribers (mostly families with young kids) are considering cancellation and moving to Disney instead – that’s potentially 21 mm subscribers. On the other hand, 20% of Netflix subscribers are expected to subscribe to both Disney and Netflix. Room for both? It’s called competition. Netflix is currently priced like a monopoly.
I was fascinated to read Netflix engineers aim for subscribers to click on a programme within 10 seconds. Must be something wrong with me. I often can’t find anything I fancy watching. I don’t have time to get sucked into series I might not like, and they don’t carry classic Kurowasa classic movies, or John Wayne’s Calvary Trilogy! Instead, I flip to Amazon prime or even the BBC.
I suspect I’m not alone in wondering if I really need Netflix. I recently dumped Spotify, and wasn’t struck by a thunderbolt for doing so. I moved to Apple – another competitor in Netflix’s space!
I was reading about who watches what on Netflix. 72% of Netflix’s watched programmes are “library programming”: The number 1 and 2 shows on Netflix are US version of The Office and Friends. They are classic TV programming and they attract pretty stable audiences. In fact only two of Netflix’s own shows are in its top 10 (according to the WSJ) by viewing time: Stranger Things and Ozark.
Stranger Things got 27 bln minutes of viewings last year. The Office was watched for 46 bln minutes. Even more interesting is viewings of Stranger Things spiked from practically zero to 11bln minutes in the month around the launch of a new series, but then fell back dramatically to less than 1bln a few months later. Viewings of the Office consistently exceeded 3 bln nearly every single month. The lesson? Old classic programming is a better more reliable content filler than new stuff, which needs constant reinvention and replacement.
What would NetFlix do without their library content? Both NBC and WarnerMedia are setting up their own streaming platforms. Over half of Netflix’s library content could go back to competing streaming services. Netflix spins that as a positive: the chief content officer saying: “more of our money to be able to do spectacular new titles.” That’s utter nonsense. No one is subscribing to Netflix for its new content! Its more likely Netflix will accept paying higher licence fees to retain the older popular programmes. The numbers show it’s the old stuff, not their new fancy content that subscribers want!
Netflix is paying $60 million to Beyonce for 3 feature “specials”. It’s a great deal for her – she launched a new live album to coincide with the first programme release.  They also paid $40mm to Ricky Gervais for a couple of programmes, and we don’t know what they paid David Attenborough to narrate their nature programme. They are spending even more on hit show makers including the team that made Grey’s Anatomy, Glee, and similar.
If you are a Netflix subscriber.. Enjoy.
Are they making the wrong stuff? Back in the dark mists of long ago, I wandered into Blockbuster to rent something just out the cinema or that everyone else was raving about. If I can’t get Game of Thrones on Netflix, I may as well rent it from somewhere else… and could that be true of just about everything Netflix is producing – no matter how good it is?  
I suspect it all means Netflix has to change. Either it needs to start advertising – and that probably means a more expensive non-advertising service, or it starts monetising its “big data” collected from its customers – which will no doubt attract much noise. (See Facebook comments above.)
I’ve got a better idea…
We all accept viewing habits have changed. I want to watch what I want to watch when I want to watch. I demand the right to binge watch. So, I want to go somewhere I can download anything. If I need to pay $40 to get Game of Thrones or $1 for the whole series of Citizen Smith.. I’m inventing a Trivago, an Ebay, of Content.. a content shop.. (I won’t call it Blockbuster… but that’s exactly what it will be..) Prices can be set according to demand and timing, or what suppliers will supply at… Disney ain’t stupid – there is a cost (a premium cost) they will sell the Lion King, or any of their content, without a subscription… In such a world, Netflix just becomes another content provider…
My competition in this space will be Prime..
I’m off to discuss it will some chaps later…
But first… back to the day job.. .
Bill Blain Shard Capital