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Royal Bank of Scotland to investors: 'Sell everything'

Discussion in 'Sports and News' started by Dick Whitman, Jan 12, 2016.

  1. The Big Ragu

    The Big Ragu Moderator Staff Member

    Right. They are fairly saturated in the U.S. There are still some developed markets elsewhere, where they still have room to penetrate pretty far. It's been a part of their narrative for a while. That, how much money they are spending on content creation, are their two big themes.
  2. doctorquant

    doctorquant Well-Known Member

  3. Hermes

    Hermes Well-Known Member

    It's dizzying how many original shows Netflix has in its library. Just tucked away in the app where I bet 80 percent of the users never see many of them. The model just doesn't make any sense.
  4. The Big Ragu

    The Big Ragu Moderator Staff Member

    I don't agree. Netflix raised its prices. ... and the number of subscribers grew impressively during the quarter. They have been growing subscribers quarter after quarter.

    Their problem isn't their value model. They are offering something that people love and they have saturated the U.S. market, and are trying to snatch up subscribers all over the world. I'd argue there are two problems not related to the actual product: A financial model problem and a valuation problem. But in terms of the product itself? It's great. The results bear that out.

    In terms of the financial model, though, they have achieved their growth on the back of a massive amount of debt accumulation -- being allowed by manipulated debt markets that are funding things recklessly. The company now has about $22 billion in long term debt and other obligations. ... and it is not slowing down on the borrowing. The market won't cut them off (as a free market would if lenders perceived being on the hook for the risk), because price discovery in the credit markets has been thoroughly destroyed. Same as it was to a much smaller degree, when short-term interest rates were administered to be way too low for years in the name of "stimulus". ... and it led to banks giving half million dollar mortgages to people with no verifiable income in 2003 and 2004 and 2005 and 2006. This is what happens when you have a small group of price czars administering the most important price there is -- the cost of money. And honestly, "administering" is a charitable way of describing their actions. It's not like they ever act as the party pooper. They only know how to spike the punch bowl and create credit messes.

    In the wake of their last self-induced credit mess, we needed a deleveraging. But they didn't have the fortitude to allow the necessary "failure." that was necessitated by what THEY did. So they dropped interest rates to nothing, and because that wasn't enough anymore to prop up their mess, they stepped into worldwide debt markets one by one and started buying up trillions of dollars of bonds (with money they created out of thin air) to drive up the prices and drive down yields. They are still at it. Close to a decade later, central bank balance sheets are still expanding and financial conditions are looser than they were when they first jumped into their rabbit hole. ... they are left blowing the bubbles bigger and bigger (and setting up the fall to be bigger and bigger).

    That keeps it too cheap to borrow, and will make the next credit crisis much more severe. It allows governments to keep racking up debt, and most are at debt to GDP levels we have never seen before. It creates a trillion dollars and growing of student loan debt in the U.S. A looming subprime auto loan mess of more than a trillion dollars. Record amounts of revolving credit card debt. And it allows companies that would never be able to attract financing to borrow at will, and do it at rates that don't reflect their risk.

    Netflix has been a borrowing machine. And it's cash burn rate has been staggering the past few years. That works great as long as the junk debt market will keep financing what they are doing and not care about cash flow. There is no organic growth there. ... yet, at least. And even if they can turn a corner and finance their growth via self-generated cash flow (something they themselves are saying they can't do, as they prepare to borrow billions more this year), their massive debt load isn't going to go away. Just servicing that debt in a normalized interest rate environment not being price fixed by monetary authorities is going to be a huge problem.

    Without a giant credit bubble that has been spurred on by central banks price fixing borrowing rates, there is no way Netflix would have gotten to where it is. If (and really, it is more a question of when) there is a credit crisis because of all of the misallocated capital that has created ghost companies and overleveraged entities and borrowers on the hook for their crap, Netflix's debt is going to be an anchor on the company. When rates rise, because the BOJ and the ECB and the Federal Reserve can't keep their thumbs on the scales of finance any longer (whatever the catalyst that creates the next panic), Netflix is going to have difficulty servicing that much debt with that financial model.

    As for the company's equity valuation. ... all of that money I mentioned that central banks created out of thin air to buy bonds (overpaying by definition)? That has created a giant casino in risk assets as that money filters through the banks. Companies that are growing their earnings anemically or not at all, borrow money and buy back their own stock in order to engineer higher stock prices (the stock market, which SHOULD be fueled by earnings no longer has anything to do with them). Big banks and high frequency momentum traders loaded with free central bank money (and at huge leverage ratios because there isn't a free market to keep them in check), chase things without any regard for price. Which is how you end up with a company living on borrowed money trading at 250 times its trailing earnings. i.e. -- a valuation problem. Anyone who buys the stock at that valuation without any understanding of how expensive the company's earnings are, is treating their money like its at a roulette wheel.
  5. Pete

    Pete Well-Known Member

    I agree with part of what both Hermes and Ragu said.

    Netflix has essentially turned itself into a TV/movie studio, except one that distributes its content directly to the consumer via streaming for a monthly subscription fee, rather than distributing via movie theaters or licensing/selling to TV networks. It's like a giant HBO, but streaming-only. They're spending huge sums on creating original content, and as Ragu notes, they're able to spend that massively because they have easy access to cheap debt and the equity markets aren't currently concerned about their debt levels as long as they keep growing.

    So yes, as long as they keep growing the subscriber base rapidly, they're still in good shape. But as we see, they've already saturated the U.S. market, and eventually your international growth will likely slow as you run out of untapped markets that are a fit for your content (or what you can create) and distribution. Though, that's life – no company can grow rapidly forever.

    What would worry me about Netflix long-term is that it's sinking its budget almost entirely into original content, not licensing content that's already popular, which is how it was built. Original content is a tough business with booms/busts and shaky margins, because nobody can make hit after hit. IMO one reason it's such a temptation to get into original content is because it's more fun than just selling other people's content. If you score with a hit show, you can win awards, walk on red carpets, and rub shoulders with celebrities. Netflix execs weren't doing that 6-7 years ago.

    Plus Netflix's first few shows were very well-received – though nobody knows just how financially successful because Netflix releases no viewing stats besides some cherry-picked highlights. That level of early success tends to make people think they've figured out the "formula" to create show after show that's both critically and commercially successful. So they start spending more and more, just like they're doing, not just in total but per project – bigger, better, bolder! Netflix also has a tremendous amount of user data, which is indeed very valuable but also can lead one to be even more convinced that they've cracked the code. Those old-school Hollywood guys were just guessing what would be a hit; Netflix has data! (Amazon claimed the same thing, and their hit rate hasn't been impressive.)

    You're already starting to see some Netflix shows that get cancelled after one season, which hadn't happened over its first few years in content creation (I believe). The budgets are getting bigger and bigger. The Get Down from Baz Luhrmann reportedly cost $120M, which is one of the most expensive shows in history, and got cancelled after one season. Like everyone else who plays big in the content game, they are going to have big busts that lose lots of money. They probably have already had some other flops, it's just that nobody knows what the ratings are.

    You know what doesn't tend to lose lots of money – buying the rights to shows/movies that have already proved popular. Netflix's business model used to be to let the content creators take the boom/bust risk; they focused on superior and unique distribution of the content that rose to the top, which has been their core competence. Are they going to turn out to ALSO be the best at the content creation game? Maybe so. But that's a lot to ask given that it's an entirely different skillset.

    They may feel that they have to go this route because content creators are increasingly trying to keep their own content and try to distribute it directly themselves, like Disney in particular is trying to do. So if you can't get Disney's content, for instance – and Disney is going to be taking its content off Netflix when the deals expire – then you might well think you need to make your own. But IMO Netflix started that trend, not vice versa. If they had stayed distribution-only, or at least distribution-first, then that showdown never starts. But the Hollywood lights beckon to dreamers of all sorts, from the next kid off the bus from Kansas to Goldman Sachs guys who think being a movie producer sounds like fun. (Mnuchin actually succeeded, but those guys generally lose their shirts.)

    As to whether you should buy or sell the stock – and more importantly, when – I have no idea. Sorry. But I think Netflix has traded the safer if less exciting business model that brought it to great success for a glitzier but far riskier one. Good luck!
  6. Pete

    Pete Well-Known Member

    I just wanted to break up the Ragu posts with one even longer. You're welcome.
  7. The Big Ragu

    The Big Ragu Moderator Staff Member

    Pete, Everything you pointed out about them spending billions to try to be a subscription-based movie studio is correct. And your analysis about whether that is the way to go in the big picture, is probably pretty astute. My only point with regard to that was that you can't argue with their subscriber growth. They are selling something that people are buying.

    But take a step away from that, because what started this was the panic buying in Netflix last night. You have a company that is burning through cash (doing what you pointed out), has something like $22 billion in long-term debt and other obligations already. ... it has plans to take on several billion more of debt this year. ... and oh, by the way, the company's stock is trading at 250 times its trailing 12 month earnings. What would you say about those fundamentals if I described ANY company that way? What other periods in the history of equity markets have we seen that kind of thing and what was the eventual result?
  8. Pete

    Pete Well-Known Member

    Irrational exuberance?
  9. Michael_ Gee

    Michael_ Gee Well-Known Member

    I think it's imitation of the Amazon plan (also the Google and Facebook plan). Do whatever it takes to gain more share in more markets. Then whenever you get close to a monopoly situation, start the squeeze for profits.
  10. The Big Ragu

    The Big Ragu Moderator Staff Member

    Amazon, Google and Facebook are all very expensive stocks, and Amazon is at at a valuation that will go down as ludicrous when the everything bubble pops.

    But a major difference in their financial situations is that all three of them have positive free cash flow. Netflix doesn't. That includes Amazon, which has increased its debt dramatically over the past 3 years, in particular to finance the Whole Foods acquisition (it chose to, though, it didn't have to).

    If you look at those companies on a spectrum, you have Netflix that is burning through cash and has borrowed heavily. You have Amazon which has borrowed quite a bit too, but has positive free cash flow, meaning it has an actual business that isn't being predicated on escalating debt-fueled growth. Facebook is virtually debt free, generates way more income than Amazon or Netflix and has much greater free cash flow. It's something of a free cash flow machine. And Google (Alphabet), which generates way more income and revenue than Facebook, has close to twice the free cash flow, but is carrying a bit of debt.

    Google is by far the strongest of those businesses. Facebook is second (it has a pristine balance sheet). Amazon is a very distant third. And Netflix doesn't belong in any conversation related to any of those others, EXCEPT if you are discussing stock valuations that are out of whack. And even there, it is a matter of degree. Amazon trades at a trailing P/E of something like 350. Netflix at 250. Those are stock prices that are in batshit crazy territory given the earnings. Facebook and Google, on the other hand, are at 12-month trailing multiples of 37 and 39 respectively, which make them very expensive stocks. But at least someone trying to rationalize owning them can try to make a fundamental case for those valuations without getting completely into pets.com sock puppet territory.
  11. britwrit

    britwrit Well-Known Member

    I do think Netflix will eventually crash but as a long-term strategy, what they're doing isn't ridiculous. They're looking to establish themselves as one of the handful of steaming services that will endure over the next few decades. Get in there and become the standard. It's something that's worked in other entertainment fields.

    We've had the same handful of large movie studios forever. ABC, NBC, and CBS still make hundreds of millions a year. Marvel and DC are still the big two in comics. Yeah, with the advent of new technologies, that's going to change. But they've had longer runs than nearly anyone here has been alive.
  12. JC

    JC Well-Known Member

    Is there a financial blog out there called firethebigragu.com?
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