Bear's Q3 earnings thoughts: Vol1

Investment Analysis Clubs Saul’s Investing Discussions
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A lot of interesting earnings last week. Even though I didn’t own any of them, I’d like to share my thoughts on 4 companies I’ve been interested in for a long time: Netflix, Skechers, Atlassian, and Paypal.

Netflix (NFLX): Netflix reported a great quarter on October 16th, to which the market mostly yawned, because the stock is up more than 50% YTD. They beat on revenue and missed on EPS, but I (like most) was more interested in subscriber growth. While they are still adding customers at a great pace, I have to worry about this one. They’re over 100M subs, but the stock seems to be trading as if they’ve already hit 300M, or will inevitably hit 500M. I think there’s a lot of danger here, especially opportunity cost. International is strong, but they have to compete with Amazon, HBO, HULU, soon Disney, and I’m sure more will come. I’m not saying it will be winner take all, but Netflix used to be the default, and now it’s not so simple. If they nearly double to 200M subs, that’s roughly 30B a year in revenue. If they can get to a 10% net margin, at a PE of just 20 that would support a valuation of 60B. They’re at 85B now. Sure, you can argue that a PE of 20 is low, but remember, that’s if they can double subscribers! This thing is so expensive right now.

Skechers (SKX): Skechers regained the market’s affection when they reported on 10/19. Absolutely Skechers was due for a little margin expansion. A PE of 13 or whatever was very worry-driven. But they’re not going to start growing at 30% consistently once again, I don’t think. PE is now 21.5, and I can’t imagine it stretching too much over 25. So again, I think it totally deserved the ~40% pop, but I’d say this one is now back to fair value.

Atlassian (TEAM): Atlassian also reported a great quarter on 10/19. This is one SaaS play that I believe in, but it’s just plain expensive (Veeva is another). The company grew revenue 42% this quarter, but it trades at an almost SHOP-like PS ratio of 16.5, and a PE of 128 based on adjusted earnings. To make matters worse, their OpEx grew at 48% for the quarter – spending is growing faster than revenue! The market loved it, and shares rose ~25% Friday, but are giving back a bit of ground today. I just can’t get interested at this valuation.

Paypal (PYPL): Paypal beat on both EPS and Revenue in impressive fashion. The 20%+ revenue growth (an acceleration from high teens growth) is an impressive level for a company this mature. They seem to have a lot of tailwinds working for them, and at a PE of just under 40, I can’t find a lot of fault with this one. Seems fairly valued at worst.

For stocks I own, Mulesoft (MULE) reports Thursday after markets close. I was considering adding when it was around a PS of 11, but it’s risen 17.5% in October and now sports a PS of 13. I’ll check out the customer growth they report on Thursday and then see what’s what.

For the rest of my companies, I’ll have to wait until at least next week.

Bear

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Bear:

I agree with your assessment of Netflix. I bought it 4 years ago, and its been a nice ride. Up nearly 500%. But Disney pulled their content, and total content is down nearly 50%. HBO no longer sells Game of Thrones for example to Netflix. Disney is the elephant in the room as far as I can see. Disney has a massive war chest of content, and will soon start streaming. Its hard to figure those with thousands of movies in their vault won’t be successful streaming and those that stream, and have to rent their content will have some problems.

Netflix is spending their money on content (so far, so good) and very little is falling to the bottom line. I’m not betting against Netflix, but their days of blue skies and calm seas are behind them, and the sharp knives of competitors are coming out.

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Netflix is spending their money on content (so far, so good) and very little is falling to the bottom line. I’m not betting against Netflix, but their days of blue skies and calm seas are behind them, and the sharp knives of competitors are coming out.

Yeah, great point. I didn’t get too in the weeds, because I really don’t want to start a NFLX debate, but they are spending huge amounts on content. Content spend was 6B or 7B in 2016 vs ~9B of revenue. That’s not a lot of margin for S&M, R&D, paying the employees and keeping the lights on. Of course they hope the content they bought will drive revenue for years, but if they miscalculate on the longevity of shows (amortize spend incorrectly), it could really bite them down the road with a big write down of intangible assets.

Maybe the way to put it is that they’re a media company that’s trading at SaaS multiples. Profitability is here, but it’s hard to see how margin expands past a certain point. Disney doesn’t even have 20% margins…and they’re Disney. Give NFLX a 20% net margin (read: probably not possible ever) and they would have had 1.75B of earnings in 2016. PE would still be near 50!

As I said, I don’t want to start an argument over Netflix, but to anyone who holds a large position, I simply recommend that you consider redeploying part of it elsewhere. It’s been a great ride, but that doesn’t mean it will inevitably last forever.

Bear

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To me it’s all about the subscribers. If they keep adding 5 million (and growing) or so per quarter and content costs stabilize in the next couple of years like they anticipate (which increases margin) I don’t see the problem. Now that’s all a big if… you are paying for Netflix currently what they may be earning in 5 years… or more… and that’s if things go perfect. They have executed very well since the Flixster debacle and say what you will about competitors, but they just don’t hold a candle currently to Netflix. I have yet to have someone say to me “Hey did you see that new show on Amazon/Hulu?” However, I have been asked that multiple times about Netflix shows. They have the dominant brand and its damn cheap. I see another price increase in a couple of years and I’d wager it has no drag on subscriber growth as this last one won’t either to any significant degree. People love the service and the content and they are willing to pay the small price for it. Anecdotally, I do not know a single friend or acquaintance who isn’t a subscriber. Even my parents, in their 70’s, subscribe (you need to know my parents to understand how amazing that is).

Netflix’s current valuation is ridiculous. I cannot and will not argue that. However, I see Netflix with 500 million subscribers in several years due to the international growth of mobile broadband across the world. From 2013 to 2016 the subscriber growth rate is anywhere from 25-33% per year (doubling subscribers every 3-4 years). That is incredible to me and if they can continue to execute as history shows, the current valuation may be lofty but also deserved.

Just my 2 cents…

MC
Long NFLX (around 30% of overall holdings and I haven’t bought a share since 2009 and sold some to get away from the 40+% it had become over the summer).

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I have yet to have someone say to me “Hey did you see that new show on Amazon/Hulu?” However, I have been asked that multiple times about Netflix shows.

Personally, when the subject of shows comes up I get a much wider range of shows. HBO probably tops the list, followed by Netflix, Amazon, Showtime, and regular cable or network TV very close together.

In fact I’ve had a couple people complain about content not on Netflix any more. Clearly NFLX is worried about losing content with all their investment in original content. I’d personally rather pay for HBO streaming than Netflix if given the choice, though I suppose there’s room for all competitors as simply different streaming channels.

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"Personally, when the subject of shows comes up I get a much wider range of shows. HBO probably tops the list, followed by Netflix, Amazon, Showtime, and regular cable or network TV very close together.

In fact I’ve had a couple people complain about content not on Netflix any more. Clearly NFLX is worried about losing content with all their investment in original content. I’d personally rather pay for HBO streaming than Netflix if given the choice, though I suppose there’s room for all competitors as simply different streaming channels."

Again, it’s all anecdotal and people will have their preferences. HBO is just something that doesn’t interest me personally or my family. GOT is the only show I know of on HBO and it’s just softcore porn with a plot (at least the couple of episodes I watched) and that kind of thing just isn’t my cup of tea. I think my original post’s point bears itself out when you look at HBO subscriber count over the last 3 years… HBO hasn’t moved the needle at all and is actually down from it’s high in 2014. HBO had 134 million users in 2016. Netflix is rapidly closing in on that number and projections are for 170 million by 2020 using Piper’s conservative guidance (others think it could be closer to 200 million).

Anyway, I like conversations such as these, they make me gather, interpret data and think… one needs to think about one’s investments a lot.

MC
Long NFLX

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