Welcome to trade ideas. I’m Jake Merle sitting down Andrew Friedman communication sector head at hedge eye, Andrew
It’s great to have you on the show great to be here
So today we’re gonna be talking about Netflix the company just reported the largest paid subscriber miss in company’s history as a streaming service
Yeah, I believe they were expecting five million or so subscribers. They only got 2.7 what’s going on? Andrew should investors be worried. Yeah
Look what we’ve been saying for the good part of this entire year is that growth is going to slow across the board?
we’ve been tracking data that tracks the number of subscribers ins for Netflix for a low for a long period of time now and
The growth rate has just continued to slow and I should investors be concerned
Yeah, I mean, I think this is the beginning of the end for the Netflix grow story now
Could they have a couple more good quarters in them? Sure
But I think as we look at increased competition and go into 2020 and beyond, you know investors that are running
You know five million net new u.s
Sub ad models and 30 million international sub bad models with 25 ARPU, you know, they’re really gonna have to start
You know stress testing their assumptions and that, you know doesn’t support the out your evaluation whatsoever
So I know there are a lot of different moving parts to this Barrett case why?
Specifically do you think Netflix is a good short?
Look, I mean we could talk about valuation all we want
I think what it comes down to is that growth is gonna slow meaningfully that there’s the addressable market that the Bulls are
You know putting this huge multiple on just doesn’t exist
you know, they’re trying to
Expand their just market grow accelerate growth by cutting pricing in India
We’ll see if that actually works but I don’t think they’re gonna be able to make any money when we look at the US
market in particular
There’s 65% penetrated. We’ve done primary research that suggests that there’s just not enough
new subscribers left for them to go after
And in that scenario where you know, maybe they do flatline at 60 to 65 million US subs a year
That would be really bad for the financial model and for the stock in that scenario
It’s really hard to model how they ever gets you free cash flow breakeven
And remind you this is a company that does cannot fund itself that burns up, you know, where from 3 to 4 billion
Cashiers completely relying on the capital markets and so I’m sitting here looking at the longer-term model looking at my growth
It’s more consensus is I’m like man if they just you know, miss by a little
This there’s so much downside here at the same time. We’re a peak leverage peak growth and
Investor sentiment you’re just having conversations with investors had a lot of them over the last three months, you know
It’s a completely consensus long. And I mean short interest is an all-time low sell side sentiments all-time high
So, you know as far as I see it, it’s a really great set up on the short side
So I you know, I think that this is just the first of many
Big misses to come for the company as the whole narrative
Shifts, so the company has slowing growth and they consistently burned through cash. But what about competition?
What does that look like for the company? It’s getting worse. I mean
People the Bears those who have been short the name for years, right?
I’ve always talked about competition whether it’s from prime who Luke what have you and they’ve lost content on the platform before right we’ve seen
The Fox content slowly come off going to Hulu but I think why this time is different than in the past
Is that those services didn’t have 30 million subs like they do today. They were fairly under penetrated
Also Netflix was under penetrated too. They had twenty thirty million subs as well
And so when you think about modeling out the future growth of the company, they’re following an s-curve, right?
You have this whole shift from over-the-top and linear to streaming and it’s following this natural progression that you’ve seen both growth growth stories
Follow and in that period you can have a rising tide that lifts all both scenario
I mean Reed Hastings has talked about it on the conference calls for years. So saying that look we’re doing well. So is HBO
Everyone’s growing but what we’re seeing now is that we’re hitting the point of unit saturation in the market
Everybody has Netflix and the folks that don’t have Netflix are probably not going to subscribe if they haven’t subscribed to this point
especially in the US and
With increased competition. That’s when you actually start to see the negative effects start to impact
Netflix this model, so when we look at Disney launching there’s competing streaming service, November 12
All that pay all those very popular movie titles coming off a Netflix service going on to Disney
I mean that is you know the first time we’re seeing big box office type stuff be
Transferred and launched on a competing service at the same time. We got news this last quarter
That friends is leaving the offices leaving albeit over, you know the next couple years, but still it’s a you know
Content is what matters right real vision hedge eye. We’re all we create content, right?
Hopefully I’m not sitting here and boring everybody that’s on this. Let’s listen to this right now. Not at all in. Yeah, but um
But but that’s the point right? We’re all here because we’re trying to create great content
So if all of a sudden you’re losing that content that everybody loves and then they’re raising price aggressively
Then the relative value just goes away and then people start to question. Why am I paying fifteen dollars a month for this?
Why am I paying seventeen dollars a month for this?
Disney’s only charging me seven dollars a month. So as you face unit saturation that part of the growth curve
Netflix has 90 percent of market share, you know, that’s not surprising
They are the first ones to be in this space and it’s kind of just math
Right you throw more entrance into the market with great content there share on a unit basis
So does their share of viewership?
and that and then all of a sudden a model that was usually
Or used to be driven by sub as now has to be driven by price, which becomes challenged at the same time
They have massive content obligations
That they’re that are fixed, right? So this isn’t the Netflix of
2011-2012 when Reid made the big pivot to streaming, right?
This is you know
I’ve say this all the time right but it’s like they were Ferrari going down the highway and they’re able to just weave in between
Cars now with all the content obligations that they have that are largely fixed and committed to in advance
It’s like more like a Mack truck
so it’s not surprising for me to see here Reid and the management team saying look we’re doubling down on our strategy because the
Alternative is really just not feasible at least in the very short term maybe over a multi-year period but you know
We’re all dead in the long run and Netflix could be $100 stock. Like that’s completely realistic over
What time Rison do you expect that look I mean so you asked about?
Competition right? It’s a great question. There are surveys that suggest that
28 30 percent of Netflix subscribers would cancel their service if they lost the office friends and Disney
now those surveys tend to be overinflated, but even if you have 10 15 percent incremental churn
And they lose six to ten million subscribers and talking about in the u.s. Not even the International side
Forget it like you’re talking down sub growth for a stock that has no cash flow those investors
Those growth investors are gonna hit the hit the doors all at once. So, you know, it could be get really ugly really fast
It depends, you know, I you know, I’m not going to hit pull the fire alarm and say it’s going to be $100 stock tomorrow
But if the setup exists where they did put out these kind of aggressive
sub targets for the back half of the year if
they do not hit them or they miss them like they did like this last quarter and they has a take down guidance for the
Year at the same time they have to raise capital and they’re come and you have a ton of competing streaming services launching
Like you can’t own the stock
You just can’t so I think there’s a lot of people that are hoping that you know, this was just a blip
But I think it’s really a shot across the bow
So Andrew, you’re painting a pretty bearish picture here, but what could Netflix do to salvage the situation?
Yeah, I mean that’s been the push back a lot of the push back I’ve gotten is that you know?
I trust trust management Reed’s a genius. I’ve heard that narrative a lot
Yeah, I mean, I’m not sitting here and saying that’s a bad management team
But at the end of the day like it doesn’t matter who you are
You read, you know, he’s gonna have a hard time coming up with the limitations of his stressful mark, right?
So what could they do?
They could launch an ad-supported service. Right? And when we think about our process and how we think about our short thesis
You know you lay out the risks, right and you always ask yourself
You’re always very paranoid, especially as a short seller. Where could I be wrong?
And if they do launch an ad sponsored tear, I think that would unlock a lot of incremental subscriber growth just because they could charge
$5.99 a month make up. The rest on ads the implications for the rest of legacy media
I think would be really devastating because you have to think about what the lifeblood is that’s funding all they’re competing content
Which is a lot of its ad dollars. It’s a hundred percent margin stuff
So as that as they kind of suck that away by launching an ad service
right, it impairs their comp their competitors ability to create content and
on launched streaming services, so it keeps the whole Netflix Bowl case the whole
Content flywheel going at a very very fast rate
So I’ve been the I’ve always thought that that if they launch an ad sponsored tiered that that would be you know
Help fund their growth drive tap into an incremental subscriber. They could do without being
Cannibalizing existing and then it would also help them on the international side as well
It’s a really crack markets like India, which don’t have
You know a consumer base that’s used to
Paying for premium video subscriptions, that’s use of services like hot star that Disney owns
That is all ad supported. So I think that’s one thing
You know, maybe they could get into sports and live news, but I think that’s kind of neither here nor there
I don’t I don’t think that’s a big deal like as far as I see it like where I get blown up
on the short side that can keep the growth going for another three to five years like really solid is
if they launch an ad sponsored option and would you have a stop loss on the upside just in case any of these things do
play out so part of the process right and I mentioned like not getting blown up is how can I track my
Thesis in close to real time. So we build out longer-term adoption models, you know, we have the s-curve
we look at how many subscribers are left in the market for them to go after so it’s kind of
Looking at a combination of you know, pricing studies demand models
Primary research survey work as well as high frequency alternative data that we can use to you know
Make sure that you know the key metric that matters which your subs isn’t going against us
So throughout the quarter we saw, you know, we tracked app downloads
We saw the growth rate just completely just roll over and we flagged that
And that kind of gave us conviction that look there’s either going to be a big problem
You’re gonna miss the quarter or they’re gonna miss the guys like something Bad’s gonna happen
Like sometime like very soon and you know ended up playing out so you know how when I think about stop-loss
I don’t really think about that in terms of valuation
I just think about in terms of where the trend in the fundamentals are going if the data that we’re tracking
Suggests that look India, they’re cutting in India, right?
I’m gonna look at India app downloads so launching a mobile only service if that starts to accelerate or hockey-stick
above and beyond what I’m currently expecting I
May cover the short because they’re gonna crush the number but you know, that’s so far. The data is not doing that. So I’m okay
And I also don’t think management did themselves any favors by setting expectations so high for the back half of the year?
so even if they do hit the number, it’s questionable whether the stock even
performs well to begin with
So that’s kind of how I think about it as long as the data and the fundamentals continue to trend in my direction
I’ll stay short because
valuation is always the last thing I kind of look at because
Stocks go crazy valuations make no sense. And you can make a lot of money being long names that our growth is accelerating
It’s working and vice versa on the downside, especially if you put leverage on it, you know
there is almost no bottom for a company that’s burning through three billion dollars a year in cash and is
Relying on capital markets, even if you are Netflix, so that’s kind of how I think about it
But um, yeah, I mean, we’ll see what happens, you know, everything has a price so Andrew
I’d like to back up a bit and hit on a point you mentioned earlier and that’s competition
Specifically Disney Plus that’s coming online in a few months and I’m just curious people are calling it content wars
How important is original content and are you bullish on Disney? Yeah, I mean we’re wily as bearish as we are Netflix
We’re equally as bullish on Disney and we think that the Disney Plus launched along with you know
Hulu and the SBM Plus altogether
Starts to look a lot like a Netflix killer
Right and it’s not that any one standalone service is gonna take them out when I say take them out
I mean Netflix, but you know the amount of content the complementary offerings that they have is a really
You know superior value of value driver
So you think about Netflix?
Charging $12.99 a month you put Hulu ESPN and Disney Plus together and you can get to a price point maybe if it’s bundled
Almost the equivalent of that of Netflix, maybe a couple dollars more and you’re really catering to you know
All people in the household, you know people who love sports
You know you get the any movies as well as the adult entertainment on Hulu, so we’re really bullish on the launch there
We think that in year one, they could probably get at least 20 million subs in the US
Haven’t seen anyone else kind of talk about you know
How many subs I can get but we think that they get to 20 million plus
Throw on the international launch as well. It probably gets a number closer to 30 million
When we get to you know called December of 2020
And what do you want to pay for that? I mean look, we’ll see
I mean, I can’t sit here and say oh, let’s take an EVP
V subscriber of Netflix and ply that to Disney right? Because we’re short Netflix and I think the valuations absurd
So it’d be a little like intellectually dishonest on me to do that
But I do think that you know can the dtc offering combined be worth a hundred billion dollars in you know?
Two or three years. Can they get 90 million?
Disney Plus subs 160 million in total worldwide when you factor in all of their three dtc offerings
yeah, I mean absolutely and you know Disney has
incredible brand infinity
Most people are aware of it. I think it’s about 61
We did the survey where 65 percent are already aware that Disney Plus is coming to market
So I think that growth is going to accelerate it’s going to take a while to Netflix this growth decelerates
And so it’s kind of like it’s a really simple thesis
But so far, you know the parrot rates worked and I think when we could roll the calendar forward into 2020
I absolutely want to be long Disney into that launch. So Disney has a few different parts of their business model
How important is a streaming service to the overall business?
So DTC, our streaming is the future Bar None like this is the future, you know, they’re betting the whole company on it
So it’s extremely important now and I think that’s what’s going to drive the stock ultimately now
There’s some legacy parts of the business where you have to be a little concerned about right?
ESPN what happens to the ABC what happens to the cable and broadcast networks, right?
what happens to that revenue stream because that’s where all the profits are and look I
might top-down view is that you’re gonna start to see an accelerating decline in
or the acceleration in cord cutting
Across the industry. I think you know 5% you know eurovia declines reasonable
I’ve heard people talk about 10% We’ll see my bet here. Is that the rest of the Disney legacy media business?
Stabilizes or just doesn’t get that bad
While the dtc launch takes off because I think that’s what’s going to drive the stock and in the long run
Look, you have to worry about affiliate fees
but you also have to think about what happens to the ad revenue and when you look at a
Platform like Hulu, which is commanding very high
CPM which is the the unit metric that
goes at how much it costs to reach a certain segment of your
I think Hulu could probably be larger in terms of ad revenue than ESPN and ABC combined in five years
I don’t think that’s crazy
And so in terms of future proofing the platform and you know reaccelerating growth and also just the synergy, right?
you know being able to maybe
Drive more merchandise sales by having a direct-to-consumer offering their existing distributions tremendous
So there’s just so many levers that this provides and it is the future of the company
You know, I’m not just saying that I ger said it
And we’ll see how successful they are. But you know, it’s a huge massive bet and if they fail it’s gonna be a disaster
Obviously, we don’t think they’re gonna fail. Oh we can see it being a $200 stock
You know as growth accelerates, I think it’s gonna be a big bang, right?
This isn’t like Netflix four to five million subs a year in the US
This is gonna be like 10 million subs out of the gate type of an adoption curve
It’s gonna be very quick and over. What time rising do you think?
It’ll reach that $200 target could be next year
It could be next year the stock does look pretty expensive though right now just on, you know normal valuation metrics. Thank you
Well, you know, what? Do you say to that?
Yeah, I mean look the stock went sideways for four to five years for a good reason, right?
Everyone was afraid of what was happening in the cable business
And I think that if you look at the estimate revisions on the out year
They’ve come down because they’re investing in original content and to your point before original content. It’s going to be very important
So they’re investing billions of dollars
To support growth of their dtc offerings so they have things like the mandalorian
They’re coming out with a bunch of original, you know
80 million dollar bigger budget movies that are going to be made exclusively available on the disney plus service
And all that’s gonna take a hit of earnings, but what we’ve seen time and time again at least in this market
Is that investors are willing to subsidize losses in the short term if it means?
You know future growth and some out your type of earnings story
They’re you’re gonna get to I’m and so I think Disney is really not going to be any different in that respect
and so that’s kind of how we’re thinking about it is I’m not too worried about
Earnings in the very near term as long as they’re putting up incredible sub growth. I’m okay with that
So what about the theme parks and the hotels aspects of the business because I know that’s at peak margins right now
Yeah, a very cyclical business. Does that worry you at all?
I totally I mean, yeah, remember how I said before like you’re always paranoid in this business
Especially when you’re you know, I think we add hedge
I we tend to be a little bit louder than most but when you’re trying to make big calls of conviction in you know you
Got to kind of swing for the fences when you can and when the data supports it
And yeah, I am worried because if we do go into a recession or go into some downturn it’s going to be negative
When we look at the data
It’s actually not surprising but interesting the the highest correlation to the theme parks business is the housing market
Right. And so when I think about where we are in the housing cycle
we’re not as late cycle in the housing market as we are in the in the broader market and the other thing too is
Things can go on for a pretty long time. Right and my duration on the 200 target is over the next 12 months
So as long as the parks business doesn’t you know?
As long as the consumer doesn’t roll over. I feel like or like roll over in a big way
I feel like I have some cover with the DTC business launching the housing market the data continues to look pretty decent
Especially on the pricing side which has the highest correlation. They just launched Star Wars Galaxies edge
They’re having a big capex shift from the international side to the domestic side, which I think is going to drive pricing
We’ve already seen it really positive attendance growth. We did a survey that’s like have you been ask people?
Have you been to Disney World or Disneyland the last 12 months, you know, yes or no, are you going in the future?
Yes or no?
there’s twice as many people that have plans to go to Disney World then have been in the last 12 months and
People tend to book those things well on ahead so, you know, I feel pretty good in that in the next 12 months
yes, you always have to be concerned with cyclical z’ and
How everything trends but we’ll continue to watch the data and again, you know the bet here. We’re long Disney for the DTC business
So I just need everything to just kind of be status quo and not blow up
Well, everything else takes off and I think you know, hopefully we’ll be really right on the name
Can you please break down this parish trade in 30 seconds? Yep growth is accelerating for Disney and decelerating for Netflix
Um, look, I think you know Netflix is facing our top-down thematic view, right?
we’re approaching unit saturation in the US market on the international side Netflix is
Over 50% penetrated and key develop markets, right? So that growth story is coming to an end you have increased competition
So Disney’s coming in with you know, they have 30 million Hulu subs
But nothing on a Disney plus side with incredible brand infinity and they’re starting from zero
So I think that you know, they’re all the part of the S curve where growth is going to accelerate at the same time
We’re Netflix at the part of the growth curve whether they’re topping out
so it’s really a story of winners and losers and a consolidating and
Increasingly saturated market for streaming services. So that’s kind of how I’m thinking about trying to keep trying to keep it simple. But also
we’re talking about literally trying to really go deep and the data and really
parsing the end market to you know to support the view other than just, you know, talking randomly and just oh
I feel this I think about this now. It’s like look at the data
Look at what look how penetrated they are. And you know, and how do I think that flows to the model?
That’s that’s how we’re thinking about it Andrew. We’ll see how it plays out and months to come. Thanks so much for joining us
No problem. So Andrew is bearish on Netflix and bullish on Disney specifically
He liked shorting Netflix at current levels with a target price of $100
He also likes buying Disney levels and as a target price of $200 over the next year now is add your Freedman of hedge
I and for real vision, I’m Jacob Merle