Dec 18 2020 - Netflix 2021: Lord Of The Streams, Return Of The King - Part2

So, again film ownership isn’t what it used to be. Netflix btw figured this out a long time ago. They were licensing huge libraries that nobody was watching in the early days. They quickly moved on from this approach. So, in hit TV series land, there are obviously a few assets that remain scarce as they bridge a generational divide. But beyond those when you are talking IP you really are referring to blockbuster franchise rights it seems, and their perceived ability to lower overall content development costs. Spinoffs, sequels, and prequels as far as the eye can see. For example, one could argue that Disney has achieved immeasurable success with The Mandalorian and thus seeded a global streaming service with minimal content cost because of their Star Wars franchise ownership. But as I stated earlier, this is not how I view the Disney+ launch. To me Disney+ remains a film library substitute for kids and a TV/Movie pass for the most recent hit franchise content. However, this still comes with creator expectations that I’m going to stay vested in the entire universe and don’t eventually run into franchise fatigue. Whether this will happen to Disney or not remains to be seen but Warner Bros knows what that is like and the FOX flops with superhero MCU franchises are a reminder that even Marvel IP in the wrong story tellers hand turns to dust.

This whole section could probably have been summed up with Netflix has demonstrated that they are constantly evolving with respect to content and the results speak for themselves. But I think it’s important to look at their content spend/original mix and conclude Netflix is driving the market, and not the other way around. They are obviously now in a position to spend far more on their own developed originals but at their scale they will always be licensing and acquiring content from 3 rd parties because it’s in fact great for their business. I also think you will see more demand out of some of non-Disney/Warner controlled world to work with them. (CBS is now rumored to be crossing over Star Trek to Netflix, and as someone who watched Picard and canceled I think they should do it.) So, if Netflix doesn’t want something or leaves it to a partner, odds are very high that they know exactly what they are doing. I also think with respect to ‘ownership’ investors should consider that Netflix has made crazy progress with respect to brand equity amongst top creators.

Just ask Dave Chapelle “Why he Fucks with Netflix":

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Now, Chapelle’s quite a passionate creator, who clearly still feels he was wronged by the industry (Viacom circa Sumner Redstone are the guilty parties as far as he’s concerned) and that sucks. Anyone who has ever made a bad financial decision or dealt with a crappy biz partner can probably identify with Chapelle, but as my sixth grade geography teacher used to say, “if you want fair, go to Timonium.”

But whether you agree with Chapelle or not with respect to Hollywood artist contract ethics, there is no denying he and many other creators like him have become powerful brand evangelists for Netflix. Top talent wants to work with Netflix because they treat them well and been writing the biggest checks. But it also helps that Netflix has built a streaming biz from the ground up without the legacy Film/TV biz model debt of the traditional media industry. Because as the recent WarnerBros Film Slate drama has demonstrated, change in Hollywood is never easy.

Which bring me to the state of Film/TV……

2020 has been a wild year for many industries, but there is no denying the Film/TV industry the shock doctrine playbook is in full effect. It’s as if a week doesn’t go by without some earth-shattering news…

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Or this gem from the Hollywood Reporter..

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It’s no secret the pandemic is allowing/forcing (depending on your POV) some companies to make the type of sudden business moves they could not have made pre-Covid. WB declaring their entire 2021 FILM Slate will be available day and date on HBO MAX without really negotiating with their talent/partners jumps out here. In some instances, you could argue the likes of WB/HBO are willing to burn bridges (Legendary Pictures) they don’t expect to need going forward. (If you can legally subsidize the launch of your streaming service on the back of content your partners have largely already financed you’d be crazy to not consider playing that card.)

In other instances, you could argue that media giants are positioning themselves for a new financial model the likes of which existing talent will have no choice but to live with. Whatever the case may be, over the last few weeks we have gotten a far clearer picture of what the future will look like, and again the answer seems to be more TV. WB/DISNEY have committed to output that will leave almost everyone drowning in a sea of franchise content over the next 3 years.

Some things to consider….

Is a hit film the same hit film if it goes straight to streaming?

The straight to video moniker used to be a kiss of death for a film (but a nice cash cow for some actors), and there is no denying that we have seen the big budget version of that with some of the films Netflix has financed. To be frank I have never enjoyed watching cinema replacement movies on Netflix. These are movies I categorize as expensive Netflix features that could otherwise have gone to the box office based on headline cast and directors. I say this because Netflix has made consuming episodic TV a far richer story telling experience and educational documentaries far more accessible. So, if it isn’t a franchise I didn’t want to go see it in theaters, odds are TV has something I’m far more interested in than an original Hollywood feature film on my TV.

I’m far more likely to watch a foreign film for example before the next Will Smith/Adam Sandler straight to Netflix movie. But again I’m the HBO/MCU/Pixar/FX target audience and I realize that there is a sizeable Smith/Sandler audience that Netflix is feeding. So, I’m sure some people will get excited about movies that were meant for the big screen to be available on TV, but so far it all has a very PPV Hotel or rare Amazon rental feel to it with a nasty twist. Meaning what’s a hit film that I missed which everyone else saw in the theater if nobody saw it in the theater? Answer is nothing, it doesn’t exist. Which means that great movie I heard about but never got to see now needs to outstrip all the streaming TV content I’m being algorithmically fed to actually become that great movie I missed in the theater. How do you do that? A hell of a lot of marketing dollars. But why would splurge like that if well I’m not going to pay for it on a transactional basis?

Yet, Netflix has gotten a lot of shit here, as the general view has been they been wasting tons of money trying to make the streaming equivalent of straight to video Steven Segal Hollywood movies to compete with the theaters. (But were they really ever competing with the theater blockbusters even if they hit us with metrics on reach trying to make it look that way?) I’d counter that this is far less of an issue than many people think as Netflix is again filling up different buckets with minutes of programming. I’d also counter that with more movies going day and date it’s Hollywood that faces the story telling problem going forward. If a movie is first available at home it is now competing against TV content choices vs other ‘event’ experiences. Again, episodic drama TV has gotten very good at rich story telling. I ran into this problem with the Marvel/WB superhero shows after a while, as I basically determined watching a full season of Fargo or the Crown was a more rewarding use of my time.

So, I do wonder what happens to films that go day and date on streaming other than some level of dilution as the shine the box office adds cannot be replicated at home. For example, I would never ever have wanted to experience the Joker (I mean the intensity of the music alone had me stressed out, no way u get me tensed up like that at home) at home for my first viewing of it. So, day and date there does nothing to help, but for the non-Joker demand curve and quality of content it gets them in front a home audience that can choose to spend that same amount of time on the Queens Gambit or Succession. At which point what does it mean to make a film that’s also available at the same time on TV? Seems stupid to discuss, but the supply of TV series has without a doubt diminished the library value of film content. What 20yr olds are digging up classic films to watch on date night?

This of course brings us back to the debatable question of franchise fatigue and IP rights as a path to prosperity. Disney recently announced 20 new Marvel/StarWars franchise features for Disney+ to go with film slated content over the next 3 years. The talent for these projects so far looks to be of the most expensive variety which essentially means Disney has little margin for error. I say this because the MCU is tightly woven together. I can already tell you my excitement with respect to the crossover TV series is a fraction of what it was when End Game ended. So, unlike the bucket approach of Netflix if you lose me on the whole universe, then you are about to piss a lot of money away on content I’m not invested in.

As I just pointed out, I got to this point at the end of Marvel’s TV Universe run on Netflix despite the fact that all the characters and performances were great. I just ran out of bandwidth between MCU and GOT for this, and the WB was an even earlier casualty even though I really loved Gotham. On the flip side, the Mandalorian has been masterful story-telling and far more enjoyable than any of the recent Star Wars films (I did really enjoy Rogue One). So, while I doubt Disney stumbles story wise, there is no mistaking the fatigue risks are very real. Netflix, on the other hand, by virtue of its delivery approach isn’t particularly vested in any type of content. Conventional wisdom used to say you’d rather be Disney and that the franchise IP reduces TCO versus the likes of a Netflix which in fact has to constantly come up with something new. I think today there is a case to be made that based on the scale and variety of content Netflix provides for its customers that the opposite might now hold true. If TV/FILM converge, TV wins. Now, I don’t see this happening, and I expect the box office to be back because of precisely this problem. However, it seems we are going to have to fill up some straight to streaming body bags before we realize Daddy Warbucks had this all figured out ages ago …

“LET’S ALL GO TO THE MOVIES!!”

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Netflix: Why Investors Should F*&% With Netflix

OK, industry dynamics are all fine and dandy, but what I’ve discussed so far isn’t exactly an investment case. I will say that if you are bearish on Netflix based on content spend or ownership rights you probably shouldn’t own anything in this space. (Hand your money to Cook and Bezos and move on.) Because what’s interesting with respect to Netflix is the financial picture which they have gotten nonstop shit for over the last five years now actually looks relatively appealing.

Netflix presently trades at about 9.4x CY 2020 (7.4x 2021 est) revenue and clocks in at an EV/EBITDA multiple of 45x based on roughly bl in 2020 EBITDA. Operating margins for the year will come in around 19%, and debt as a percent of market cap is about 6%. (Net debt is half that.) Not exactly a value stock, but with Apple at an EV/EBITDA OF 25X this isn’t the butt of every balance sheet/profitability joke Netflix of old. Like can anyone who doesn’t have a sudden epic churn argument in hand call this "debtflix" anymore? I’d in fact counter that in this macro environment Netflix is actually drastically under geared here.

Now factor in that HBO is headed into the red and Disney has given you DTC guide that has losses peaking next year and overall division content spend doubling over the next four years. Clearly, Netflix is no longer the financial ugly duckling of media. In fact, after the damage COVID has done to their parks/resorts business, Disney is also trading at a remarkable 45x EV/FY2020 EBITDA. Then you have ROKU at a 1/5th of Netflix’s market cap as it is set to break bl in platform revenue or roughly a 40x sales multiple. Anyway, I am not trying to directly compare the fundamentals of these overall businesses as each is quite unique, but the point is for those who love to look at the surface financials Netflix actually is one of the simplest and cleanest pictures today.

One way to look at Netflix here is essentially based on what it could be financially. The way I see it; Netflix at .40 ARPU remains a ridiculous value proposition to global consumers. That means you really don’t even need to give much thought to how many more subs they can get but rather how underpriced the product is. For example, every in ARPU works out to bl in incremental EBITDA. Some people might counter well to increase ARPU you need to increase content spend, but actually that’s not the argument here. The argument is in fact that Netflix is underpriced to the point it could in fact be commanding a + global ARPU today w minimal churn impact. That would amount to bl in incremental EBITDA or leave Netflix today trading at a 10% discount to Apple’s current EV/EBITDA multiple with maybe a 25%-30% earnings CAGR for the next decade.

This is something an investor needs to think about when they look at Netflix’s competition. Remember HBO/DISNEY are not greenfield plays. As I mentioned earlier, HBO’s varying MVPD distribution agreements allowed them to claim some 150ml global subs across HBO/CINEMAX. That works out to about a month per sub or roughly a quarter of what Netflix’s delivery/marketing costs are for its 100% OTT DTC model. Disney’s cable era non-content costs come in even lower at cents on the dollar as their media networks count hundreds of millions of global PayTv subs. Compare this to the forecasted economics of Disney+ which Disney is guiding you (a lot more honestly this time) will reach profitability in 2024 with roughly 245ml subs.

Disney+ in developed markets outside the United States is essentially being merged with Hulu/TCF content wise (prices will run -12$), and in the USA the ad free triple play bundle is going to cost you next year. Essentially if you get HULU (ad free) w/ DISNEY+ standalone you are an idiot cause you can save and get ESPN+. But this is the Disney comp today with an ARPU of .5 for Disney+ and around for Hulu. (Hotstar at 35% or so of the base is clearly a drag as the wholesale pricing and discounting they been doing to acquire subs.)

Now, I can back into Disney’s forecast model for Disney+ FY2024 breakeven at .5bl in content spend and 220ml avg subs for the year at around ARPU or essentially a 12% CAGR from today’s levels. That means Disney is aiming for Netflix level non-content monthly operating/mkt cost per sub of just .5- by 2024 for Disney+. Does that range look familiar? Based on this analysis, I figure Disney’s USA ad-free bundle will cost a month by 2024. Meanwhile across the board Disney is aiming for total DTC spend in 2024 (bl midpoint) that is roughly on par with Netflix today. I think the cash content spend dynamics are an important element for investors to factor in as well. Because as we can model what Disney will add topline wise in DTC, we can conclude more TV and DTC and less wholesale distribution and licensing will weigh on FCF margins. Netflix’s business on the hand is natively structured around DTC, and thus they have always run far higher cash content costs as financing options available to alternative modes of distribution combined with licensing demands have not comported with their distribution model. The rest of the industry, as I have alluded to a few times, is now playing catch-up here. So, if international rights or backends are no longer meaningful sources of revenue/financing for projects, well the real cash costs of content for media giants pivoting to DTC will go up. So, I don’t see how you can crunch the numbers without concluding that Netflix here is financially compelling.

This is of course the beauty of what Disney has accomplished consolidating as it has and why Netflix management doesn’t frame this as a streaming war with the Mighty Mouse. They are going to drive pricing higher and likely pressure supplier leverage over the long haul at an unprecedented global scale, and Netflix/Apple/Amazon/Google are not going to complain.

What’s the bear case?

There are always reasons to be bearish, and I can start with Covid ending being one. 2021 is not going to be an easy year comp wise for Netflix with respect to subscriber metrics. The first half will have tough year over year Covid comps, and the back half will potentially have the end of covid get out of the home and travel headwind. Meanwhile, the Office is going to be gone, Warner’s entire film slate is going to be on HBO Max, Apple/Amazon have some big projects slated to launch, and Disney+ will finally start releasing some decent volume of original content other than the Mandalorian as the MCU makes its way into the streaming wars.

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This means Netflix is going to experience persistent narrative heat and skepticism against a backdrop of financial metrics you could plot Captain America’s heartbeat too. This combined with the unique macro backdrop should make for some notable volatility. I can tell you now that if by the end of the year there hasn’t been some mass subscriber exodus and Netflix has managed to withstand this streaming content blitz largely unscathed from a retention standpoint, well, Netflix shareholders are going to be feeling really good. Because at that point its game over for any bear thesis.

P.S.

It’s almost exactly the 10-year anniversary of my Netflix short thesis and me declaring the stock finished. The shares are up about 1650% over that time. That being said If you are looking for comfort with respect to my history with this name….the stock fell 75% over the 18 months after I published my thesis….and I did have a pretty decent crystal ball….

With respect to what could go wrong as a former bull at the time I definitely was worried about mgmt……

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And with respect to what I would do if I was in charge, well, I hit the nail on the head here as Netflix went from old episodes of cheers to we are competing w HBO mantra wise over the next few years…..

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Opentable as the alternative is comical especially as I would go on to short that stock later and then flip it again, and because well I let a juggernaut slip through my fingers as I for the most part felt this was all way too obvious. Well, played Captain Twilio!!! But a decade of near zero rates also helped, and a whole host of other factors globally with respect to expansion/distribution and competition. Anyway, hope you got something out of this, and constructive feedback is welcome.

I apologize for not pairing/editing this down but, to be honest, I just don’t have the time with all the shows I’m watching.

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