Doug Kass shares his views every day on RealMoneyPro. Click here for a real-time look at his insights and musings.
Netflix Is Tuning in a Host of Challenges
Originally published at 9:25 a.m. EST on January 21, 2016
Netflix reported quarterly results since my last NFLX missive, but I was unimpressed. I see no evidence of a turnaround in the firm's ability to generate cash flow or improve margins.
The market continues to value Netflix on the basis of subscribers and the company's total addressable market (now over 250 million homes globally).
Investors are more or less ignoring everything else, but Amazon(AMZN) - Get Report , Hulu and other rivals represent an important challenge to the company. So does more-sophisticated, Internet-based "smart" television.
Netflix unquestionably has the "first-mover advantage," and has announced a significant increase in global activities that will continue for at least the next year. However, this situation increasingly looks to me like a replay of AOL, which always "beat" on subscriptions while no one looked at the company's cash flow until it reversed dramatically lower.
NFLX is clearly a much better business than the old AOL was, but I don't see how the company is worth anything close to its current $51 billion market capitalization.
Here's my take on Netflix's latest quarterly results and trends:
- Revenue growth was 23%, but that's not stunning given the company's market cap.
- One of the main issues going forward is whether NFLX can expand margins even with overseas growth. Subscribers pay with local currencies, but Netflix's largely dollar-based content costs are increasing.
- International subscribers were stronger and Netflix's overseas-penetration rate is still low (in the mid-single digits, but probably going to about 10% in the next three or four years). But we don't know how much marketing money the company will have to spend in its new non-U.S. markets.
- Domestic subscriptions are now at about 45 million, but that missed analyst expectations. Guidance on subscription growth was also weak for the next quarter, lowered by 20%.
- The company is attracting competition, and it releases little in terms of viewership numbers vs. subscriber numbers.
- Netflix has been consumer friendly from a pricing standpoint, underpricing its product to date. But price increases planned for May and October could result in a tick-up in domestic churn, while the company is inching ever closer to a saturation point.
- If margins don't increase, then NFLX's growth approximates revenue growth. But the company faces huge investments and higher content costs this coming year.
- Fourth-quarter EBITD declined slightly (by $2 million). That means $339 million of incremental revenues produced a minus $2 million in incremental EBITD. Ergo, there was operating leverage. This has happened for five quarters in a row.
- Interest costs quadrupled to $29 million from a previous $7 million. This reflects NFLX's cash burn. Cash-flow coverage of interest is only a little over 3x, so I'm surprised Netflix hasn't done a huge convert or equity offering in to raise cash.
- Pretax income declined by over 50% to $20 million vs. $45 million in the same period last year. However, a $23 million tax credit produced a $0.10 earnings per share, "beating" analysts' $0.02 consensus forecast -- to the worshipful drum beating of many in the business media. Where is late accounting icon Abe Brilloff when you need him?
- Netflix's share count grew sequentially by 11 million shares (+2.6%) and the company's stinginess with stock-based compensation seems to have ended. After all, NFLX does make its headquarters in Silicon Valley!
- Netflix's $51 billion market capitalization is approaching that of $52 billion 21st Century Fox(FOX) - Get Report and $57 billion Time Warner (TWX) , and has left $17 billion Viacom(VIA) - Get Report in the dust. But Netflix buys content rather than making it -- and while it might not be true that "content is not king," its price is definitely going up. Does that benefit content buyers or content makers?
- On a trailing-twelve-month basis, NFLX sells at 168x EBITD and more than 300x EPS.
2016 Poses Additional Risks
This year poses even more risks for NFLX, including:
- More competition from large technology companies like Alibaba(BABA) - Get Report , Alphabet (GOOG) - Get Report , (GOOGL) - Get Report , Apple(AAPL) - Get Report , etc. These firms have near-unlimited financial resources and plan to plow money into video-streaming platforms. By contrast Netflix has zero net cash (i.e., cash less debt).
- Netflix's well-capitalized rivals will push content prices higher at a time when content is already the company's largest single cost.
- NFLX is one of the Internet's largest bandwidth users, but "net-neutrality" issues could arise anew this year. The Federal Communications Commission has consistently flip-flopped on this issue, so Netflix could face higher bandwidth costs.
- There's a technology risk here. Netflix is basically an app on a not-so-smart TV. But a "pure" Internet TV -- with product transmitted by a computer -- is on the docket this year. So, NFLX might see its competitive advantage reduced.
Position: Short NFLX (small)
Netflix Gets Fuzzy Reception
Originally published at 11:47 a.m. EST on January 22, 2016
I plan to add to my NFLX short on any bounce.
Position: Short NFLX (small)
From Goats to Heroes
Originally published at 2:18 p.m. EST on January 21, 2016
" So the last will be first and the first will be last."
Jim "El Capitan" Cramer is correct, the market is nuts.
Today's feature is the outperformance of the laggards, including high-yield debt, fertilizers --Monsanto (MON) but not Potash (POT) -- integrated oils such as Exxon Mobil(XOM) - Get Report , master limited partnerships such as Kinder Morgan(KMI) - Get Report , retailers such as Macy's(M) - Get Report and Best Buy(BBY) - Get Report , Twitter (TWTR) - Get Report and others.
As Grandma Koufax would say, "Dougie, meshuganah is trump." (Craziness is threefold in Yiddish).
Position: Long TWTR (large) BGB (large), M, BBY, POT; short XOM (small)
At the time of publication, Kass and/or his funds were long TWTR, BGB, M, BBY, and POT and short SBUX and XOM, although holdings can change at any time.
Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.