The Netflix Cheerleaders Jumping Out of Their Skirts
Analysts and sell-side peddlers are raving about the recent Q2 report from Netflix. They point to a climb in the Q1 to Q2 subscription count from 99 million to 104 million users (80% of which came from overseas…) Indeed, this glorified movie studio and home-streaming service is making them giddy.
Tech sell-siders (the same who projected SNAP at 30, now trading at 15) are cheerleading for a 25% share price climb into Q3 and Q4. It’s like one great big happy ending to a blockbuster movie.
But movies aren’t real, nor is the street’s analysis of Netflix in particular or big tech in general. In fact, Netflix’s balance sheet (like the FAAMG rise) is one of the worst movies I’ve ever seen…
Fact and Fiction—And Something Called “Profits”
So let’s look behind the glitz and momentum and examine the facts. First, it’s perhaps worth noting that year to year profits (pre-tax) at Netflix have dropped by over 70% from $51M to $14M, and year to year operating free cash flow has fallen from $238M in 2016 to negative $600M in 2017.
The company’s overall market cap is at $78B, yet its operating free cash flow drowns today at negative $2B. Since 2012 to today (when it’s share price surged from $10 to $182 per share) the company’s topline sales climbed to $7.5B yet it’s pre-tax profits for the same period are up only $139M (from $268M to $407M).
Doing the math on Netflix’s LTM net income of $362M, its implied PE multiple is greater than 215X.
What is going in this tech fiction? I mean really? Call me old fashioned, but doesn’t profitability matter when cheerleading a stock? Companies like Netflix and Tesla et al seem to brush past this old idea of profit in favor of hope-selling projections.
But Netflix CEO, Reed Hastings, is just as smug as Elon Musk when it comes to current profit (“lessness”) vs. momentum projecting. In fact, Hastings sees the negative FCF as a sign of Netflix’s “enormous success,” as he happily reports that growth requires tapping into free cash flow.
That’s a lot of tapping…
But Hastings, like Musk, and the “investor-come-lately’s” (who chase growth rather than balance sheets) think everything is going to be fine. They feel Netflix is the only one streaming videos or Tesla the only one designing cars, and that historical forces like competition (think Hulu and Amazon), regulation, anti-trust laws, foreign market roadblocks and market bubbles don’t exist anymore.
So keep on buying! Keep on cheering!
Memories of the Last Fantasy Film
I was trading a hedge fund in 2000. We were up over 300%, drunk on similar tech momentum and a NASDAQ led by Lucent, Oracle, Cisco, Intel and yes, Microsoft…
Times were good, and the sell-side analysts and our Prime Brokers were as giddy then as the current crop of cheerleaders. 99% of every analyst report we got was a “buy.”
If you were trading then, perhaps you also remember that those stocks tanked. Microsoft, in a bubble then as now, fell by more than 60% after 2000 (and later fell by 45% in 2008).
But today we are told “this time is different.” In fact, a UBS equity and derivatives analyst recently said that “such declines now appear as blips on a long-term chart.”
Wow. Have we gotten this drunk again? “Blips on a long-term chart?” Really? Really?
Would you consider a 50%+ loss a “blip”?
This Time Is Not Different. In Fact, It’s Worse
In 2000, the Lucent to Microsoft trade pretty much was the market, and today, the FAAMG (Facebook, Apple, Amazon, Microsoft, Google) trade is almost 15% of the S&P and responsible for 40% of that Index’s annual performance. In other words, today’s stock market is practically a tech market.
And not just any ‘ol tech market, but a grotesquely inflated one. These names added $600B of market cap this year alone, a figure greater than the combined GDP of Hong Kong and South Africa.
Maybe you aren’t worried, maybe you feel this time is different, that profits aren’t as important as growth, and that some magical stimulus, from Trump to the Fed to an endless market without tears is possible and ready, if necessary, to be saved by such soul-enriching and economy-saving innovations like live streaming. Maybe you think sales are more important than profits. Maybe you think these numbers aren’t that scary.
If so, you’re not alone. In fact, volatility in the FAAMG pool (this is not even counting Netflix) is lower than in the S&P. Man, it’s even lower than the volatility in the Consumer Staples and Utility Sectors. Really? Yes. Really.
But when I see goofy balance sheets like those of Netflix, Amazon and Tesla (See my take on Tesla and Amazon) trading at all-time highs on rose-colored projections at volatility levels less than utilities, I can’t help but shake my head, and then shake it some more.
This is, well: crazy.
Even more crazy is that unlike the last tech bubble or even the 08 crisis, we don’t have a re-inflation “save me” button at the Fed. As so many of my other posts argue, our country and our central bank, is nearly broke and out of magical powder. (See The Fed Fantasy)
But if you feel like a few (or even more than a few) percentage points or fiscal quarters of growth is worth the downside risk of another 50% loss (or “blip”), then you better know exactly when to sell.
For most of us, the risk right now just isn’t worth the reward. Though I’m sure you’ll get some upticks. When it comes to the FAAMG’s, I’m patiently waiting to go short, not long.