To A Gamma Squeezed World
The earnings season is always excitingly engaging, and some of the heavy weights are about to report this week. One of them is Netflix.
From the capital perspective, investors/speculators are quite bullish. 4500 Aug 18th $415 Call, 4500 Jan 2025 $660 Call. Bullish put sales with March 2024, $460 Put, June 2024 $470 Put, Dec 2024 $450 Put.
We have seen enough gamma squeezes in this cycle, but such monstrous run-up for a 200 billion dollar market cap business before earnings when the Federal Funds rate is north of 5% is still quite remarkable.
Netflix’s revenue grew 6% last quarter YoY on a F/X neutral basis, and it raised its FCF forecast of at least $3.5 billion from about $3 billion. It has some tail-winds behind it, such as subscription growing again (after last year’s stagnation), crack-down on password sharing potentially boosting its revenue (but shouldn’t it have already been baked into company’s guidance of revenue and FCF growth?), ad-supported plan gathering steam, and some bulls even tie it to the AI-boom with AI-aided content creation that can be more lucrative on a going-forward basis.
Sometimes stock prices can be driven by pure narrative, and I still vividly remember when Bilibili was selling at $150/share and 20x sales and yet the bulls think Bili has substantial monetization potential if it wants (at the expense of slower growth), and attributing a Youtube status to it would imply considerably more value than its then $60 billion market cap.
Let’s face it, growth is hard.
In The Search for Organic Growth (Hess & Kazanjian 2006), Prof. Rita McGrath of Columbia University Business School examined the importance of middle management in delivering growth. She analyzed all public and non-public companies with market cap of at least 1 billion dollars and asked how many of them can grow their revenue for 5% per year for the next five years. Only 248 companies were able to do that. This shows us how difficult it is to continuously grow revenue, despite at a seemingly low rate.
But I’d like to step back and look at Netflix’s long-term growth potential, and put on some numbers in relation to its current market capitalization.
Netflix has a TTM revenue of $32 billion dollars that’s growing at HSD (high-single-digit), and it forecasts a ~11% FCF margin of $3.5+ billion for 2023. Let’s assume Netflix can grow its FCF for 20%/year for 20 years — wait, how likely is that, statistically?
I can’t find an answer just by googling, but even ChatGPT knows it’s not an easy task:
But let’s assume Netflix grows its FCF 20%/year for 20 years starting from 2023’s number of $3.5 billion, and then it grows at 5%/year into perpetuity. Discounted at 10% to the present, we get a per share value of $564/share.
As for all tech companies, take note of its SBC (share-based compensation). Not surprisingly, Netflix’s SBC was 25% of its operating cashflow of 2022. I’d imagine adjusting for SBC, Netflix’s FCF will be lower than $3 billion for 2023, chopping off a 14% of its terminal value, arriving at $483/share, which is precisely where it closes at aftermarket one day before its earnings release.
What if Netflix grows “only” at a rate of 15%/year for 20 years and then 5% into perpetuity? Discounted to the present without considering the impact of SBC, which by the way is a real expense, is $281.34/share, implying a 40%+ downside from its current market price.
Therefore, I believe the odds against the bulls are not particularly favorable, with virtually no upside even assuming a long streak of fabulous growth vs. a 40% downside if things slightly go south.
Netflix’s user engagement has plateaued at 30 minutes in the US, and based on data from Statistica, the numbers from 2021-2023 has mostly held steady to a fair modest declined in recent months.
Netflix’s subscription numbers are looking better due to password sharing crack-down, but apparently it is also reaching the saturation phase (after all, the entire population of the US is 331.9 million. )
And competitors are not in hibernation mode either. Once thought as the only viable streaming platform, Netflix is seeing Disney+, Youtube, Warner Media Discovery, and even Paramount quickly assembling a massive streaming following, and none of these players are exiting the market just as Netflix is turning to focus on profitability.
Some commentators bullishly argues that “It’s brilliant how Netflix is making content for countries and language. Shows and movies the country wants to see. India, Korea, Japan, Germany etc. Disney doesn’t have a lot of Korean programming.”
In my view, this is precisely the argument against Netflix’s purported global scale -- it does not have global scale in terms of content production because they need billions of dollars for programming investment in countries like Korea and elsewhere (for instance, $2.5 billion in Korea for the next several years). Therefore, given user saturation in developed world and engagement not increasing, the only hope for significant FCF growth which is margin expansion is dubious at best. The FCF yield prospect is simply nowhere close to what some bulls are depicting because content creation will always be local due to geography/demographics/culture.
So, if you ask me whether to put money into a Netflix with 1.6% FCF yield (or 60x FCF multiple without adjusting for SBC) or 5% treasury, I’d probably opt for the latter to wait for a more opportune time to ride the streaming powerhouse’s coattail.
Disclosure: We have a small, short position against Netflix and have no intention to cover it in the next 72 hours.
Comentários