Netflix, Disney, and Even Stranger Things

In case you were too busy “Netflix and chilling” to notice, Netflix’s (“NFLX”) market cap is essentially equal (Barron’s $) to that of Disney (“DIS”).   NFLX is spending about $3.1 billion more dollars per year than it is able to bring in (“burn”).  DIS is gushing about $10 billion net cash per annum after all of its investments and all of the money that Scrooge McDuck uses to wipe his tail feathers.  I have seen stranger things…but probably not since the year 2000.

So, pretty much everyone has made note of this.  It’s a weird/neat thing.  The link above is to a Barron’s article juxtaposing the new bubble boy and what might just be the greatest business in the history of entertainment.

Here’s the tweet from the FT’s John Authers, which prompted my own thought process to begin in earnest:

Here was my response:

In fairness, I suppose Mr. Authers simply said, “may” have passed Disney by [I think the use of passed “buy” was intended to be clever), so his tweet may age just fine even in a reversal of fortune for NFLX and DIS.

He jokingly replied to ask if I meant DIS would, in fact, acquire NFLX.  No, I do not think they will acquire NFLX.  I do, however, think it very likely they will have a chance to acquire NFLX in the future and for a mere fraction of Disney’s value.

Of course, I don’t believe I or anyone else can really predict what will happen.  Maybe NLFX will be the bubble stock that survives and grows into its value, like Google or Amazon.

The most likely outcome, however, is that the “new era” glamour stock with massive cash burn (only until it gloriously becomes cash flow positive in 2022 with a projected 81% U.S. household penetration rate; according to analysts) will end up like AOL, or Netscape, or Compuserve, or Prodigy, or Silicon Valley Bank, or Sun Micro, or Pets.com, or Webvan.

It is just the application of the base rate from historical observations of the outcome of investing in glamour stocks (and maybe a little math).  When you pay for a bunch of good things to happen in advance, you are likely to be disappointed and you already paid for it….so you get decapitated, rather than disappointed.

AOL…YOLO?

Actually, AOL probably isn’t a bad comparison to NFLX.  Speculation about DIS buying NFLX brings the TWC purchase of AOL screaming to mind.  AOL was the “first mover” and had a software suite for delivering content (most of which was created by others).  They had a subscriber base that was massive compared to everyone else and a much easier to use interface versus going straight to the browser or other applications.

Here’s a quote from a New York Times article about the old media acquisition of the new media darling AOL:

A decade ago, America Online merged with Time Warner in a deal valued at a stunning $350 billion. It was then, and is now, the largest merger in American business history.

The Internet, it was believed, was soon to vaporize mainstream media business models on the spot. America Online’s frothy stock price made it worth twice as much as Time Warner’s with less than half the cash flow.

When the deal was announced on Jan. 10, 2000, Stephen M. Case, a co-founder of AOL, said, “This is a historic moment in which new media has truly come of age.” His counterpart at Time Warner, the philosopher chief executive Gerald M. Levin, who was fond of quoting the Bible and Camus, said the Internet had begun to “create unprecedented and instantaneous access to every form of media and to unleash immense possibilities for economic growth, human understanding and creative expression.” [emphasis supplied]

In another weird/bubblelicious parallel, NFLX reportedly wants to plunk down $300 million of shareholders/bondholders money to buy a billboard company.  AOL plunked down ~$500 million in 1999 for the old media Moviefone.  They also bought NetScape for like $4 bill and MapQuest for $1 bill.  Dominant franchises…but they paid for rosy projection and no one saw that Google coming to take all their cookies.

Bottom line, paying through the nose for a fabulous future did not end well with AOL and this time around is likely to end up in a similar place.

DISNEY IS COMING!

NFLX is basically just a channel, with a large on demand catalogue available at all times.  Half their subscribers could turn them off next month if NFLX gets off the new content treadmill or, perhaps more likely to my mind, someone else comes out with better software with a more open architecture to integrate other content.

Amazon already sort of offers this via the prime video app, where I can add showtime or HBO to the prime catalogue.  You can also do this through other streaming suites, like PS Vue or YouTube TV.  A la carte or bundled streaming is really just a matter of pricing and bulk buying.

Right now, NFLX’s interface is much better than Prime video (and the other competitors) but that probably won’t always be so (or maybe it will, but you are already paying a price that assumes that will be the case).

HBO has only recently decided to get into the “over the top” streaming game (since it had entrenched interests to protect, if possible).  It added 5 million subscribers in Q4 last year, versus the 8.3 million for NFLX, but it has only recently decided to compete in this arena and has much deeper penetration in the U.S.  Overall, HBO had 142 million subscribers as of the end of 2017 versus 117.6 million for NFLX (it also has a much more robust library of valuable content….Sopranos anyone).

Ok, so “NFLX is growing faster” you will say, but is it really that much of a different animal than HBO, or Showtime, or any of the rest?  Will it continue to be differentiated now that it has proved out the business model for the rest of the industry (and capital is starting to come after it)?

When DIS launches a competing service and takes the Marvel, Star Wars, ABC, and other content it owns back from NFLX, what will happen?  Do you think Reed Hastings would walk or sprint to swap out his NFLX seat for the DIS or even TWX properties?

Let’s do a little Simple Comparable Analysis:  

–                               NFLX                    DIS                        TWC

EV                           $140 B                   $174B                   $95B

EV/REV                   11x                         3x                          3x

EV/EBIT                  164x                      12x                        13x

EV/EBITDA            151x                      10x                        10x

Wow.  The amount by which it surpasses TWC is more interesting than the DIS comp (showing once again that focus on market cap is suspect).  Hmm, TWX might be interesting.

These EVs are before NFLX slaps on another $1.9 billion more in junk bond issuance.  In another bubble indicator, NFLX pointed to its “thick equity cushion” as supportive of its debt.  This “cushion” can evaporate very quickly.  Almost as fast as Jerry Levin’s legacy (too soon?).  Of note, in support of my bubble narrative, is the resort to the equity cushion versus mentioning ability to repay the debt with cash or bitcoin or whatever.

A Sucker’s Bet

In the end, those sorts of anecdotal observations are probably just narrative.  I might be mis-applying pattern recognition that would have served my ancestors well thousands of years ago.  I also note that John Malone seemed reasonably positive on NFLX in some the videos I recently pulled together on him.

I don’t know what will happen, neither does Reed Hastings or Bob Iger, and neither do you.  If you like NFLX here, you are already paying for a rosy outcome; like…the best outcome.  That requires one to ignore the base rates and make a sucker’s bet.  It’s just like trading up for the first round pick, but your hit rate is really no better than if you pick in the second round.  I hope Bob Iger is not thinking about making that bet.

I’ve seen stranger things than  discussion of a Disney and Netflix “merger of equals”…but not since the year 2000.

Thanks for reading.

 

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