It lives in a fantasy world.
Netflix just completed a $1.6 billion junk-bond offering. The 10.5-year notes are rated B+ by Standard & Poor’s and B1 by Moody’s – four notches into junk. But no problem. Those notes sold on Monday at a yield of 4.875%, or 256 basis points over the equivalent US Treasury yield, according to LCD of S&P Global Market Intelligence.
This was just the latest – and largest – issuance in a series of ever larger bond sales.
Netflix, whose shares went from $9.94 to $192.47 in five years, is on a peculiar and accelerating treadmill: It needs to borrow ever larger amounts just to cover its ever-larger negative cash flows year after year. These negative cash flows are mostly caused by ever more spending on its proprietary streaming entertainment programming that is needed to attract ever more subscribers, who are needed to support its gigantic market capitalization of $84 billion. And that gigantic stock market capitalization is needed as a guarantee of sorts for the bondholders…. If this seems a bit circular, it’s because it is.
You’d think a company that has been publicly traded for 15 years, offers a popular service, and produces proprietary content that people want to watch would have figured out by now how to turn its business model into something that is self-sustaining. But no.
Cash flow from operations is becoming increasingly negative:
- 2015 full year: -$0.75 billion
- 2016 full year: -$1.47 billion
- 2017 Q1 – Q3: -$1.30 billion
So why can’t it find a self-sustaining business model? Because it doesn’t have to. It can always borrow the money instead of making it. That’s the logic. The bond sale on Monday came on top of a long series of bond sales.
In April, Netflix’s European entity sold €1.3 billion (currently $1.5 billion) of 10-year unsecured junk bonds in Europe at a yield of 3.625%. This is a textbook example of “Reverse Yankees” – euro-denominated bonds sold by US companies in Europe to benefit from ludicrously low costs of borrowing, including an average junk-bond yield that is below the US Treasury yield.
In October 2016, Netflix sold $1 billion of 10-year junk bonds in the US at a yield of 4.375%, at the time a spread of 263 basis points over Treasuries.
In addition, Netflix has the following bond issues outstanding:
- $500 million of 5.375% notes due 2021
- $700 million of 5.5% notes due 2022
- $400 million of 5.75% notes due 2024
- $800 million of 5.875% notes due 2025.
And that debt keeps piling up. Its “non-current content liabilities” and its long-term debt combined was $1.3 billion on December 31, 2013. Over the three years and three quarters since then, that pile has skyrocketed 530% to $8.2 billion!
In its earnings report on October 16, it announced that it would spend “$7-8 billion on content” in 2018 and that it had “$17 billion in content commitments over the next several years.”
It just doesn’t charge enough to cover the expenses. In other words, investors are subsidizing the subscribers.
It expects a negative “free cash flow” of -$2.0 billion to -$2.5 billion for the full year in 2017. And it anticipates financing its capital needs by borrowing more money.
The way the company accounts for its spending on content production and acquisition – as an asset to be amortized over many years rather than expensed all at once – allows it to show a net profit even though it’s burning through cash hand-over-fist and expects to continue to so for as far as it can see.
But the bond market doesn’t mind. The average yield of equivalently rated junk bonds, as measured by the BofAML Single-B US High-Yield index, is 5.44% — compared to the yield of Netflix’s current bond issue of 4.875%.
In other words, despite its persistent, massive, and growing negative cash flows for all times on the horizon, Netflix’s borrowing costs are lower than comparably rated companies. These are junk-rated companies with a significant risk of default. And Netflix has formidable competitors, including Amazon and everyone else out there in the entertainment business, in an industry that depends on notoriously fickle consumer preferences.
So what’s the secret? Netflix’s stock price.
Just like Tesla and some other companies that are bleeding cash in vast and never-ending amounts, their overinflated stock price acts as a guarantee – in the bondholder’s mind which has been bludgeoned by central banks – that the company can always sell more shares to raise the funds necessary to deal with its debt and cover its negative cash flow, and that therefore the risk of default is small.
And that’s true – until it isn’t. When the stock crashes, that equation goes to hell. This can happen, as unimaginable as it may seem today. Then the company has trouble issuing more shares to raise the billions needed to redeem the debts when they come due and to cover its negative cash flows. And the whole circularity falls apart.
So these bondholders are taking risks linked to the stock market, but with a return that is limited to this low yield and little else in terms of upside, under ideal circumstances if the bond makes it to maturity and gets redeemed. But if the stock crashes beforehand, bondholders get to grapple with a new reality: that the low yield didn’t compensate them for the risks.
I don’t remember ever having seen crazier times of more pandemic proportions. Read… Wall Street Piles into Cryptocurrencies, Others Speak of “Biggest Scam Ever”
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And this is why I think “Unicorns” are a bigger scam that bitcoins. Even if Netfix is too old to technicaly count as a Unicorn.
Netflix has a funny way (also completely kosher with U.S. GAAP) of accounting for the “Asset” side of their balance sheet, specifically “Content Assets” both current and non-current.
When Netflix signs a contract with, Warner Brothers, as an example to stream content … we would normally consider this a business expense. E.g., you are paying out funds to provide YOUR customers with a service.
However, Netflix accounts for this as an asset. When it signs, say, a $1 Billion USD deal with WB for a 12 month period (only an example) that $1B gets booked as the acquisition of a “Current Streaming Asset” with its value derived at the price paid. If its $1B for 24 months, $500m gets booked as “Current Streaming Asset” and $500m gets booked as “Non-Current Streaming Asset” and is subsequently reallocated in the next fiscal year and amortized.
Sounds reasonable, problem is multi-fold:
First, Netflix is able to leverage up to eye-watering debt levels as its reclassifying expenses as assets, keeping their HY covenants happy.
Second, these prices paid for “Steaming Assets” are based on an implied continuous expansion of their subscriber base. While we all know infinite growth on a finite planet is impossible, thus if their subscriber base ever shrinks … Mark-to-Market dictates they’ll have to write-down these intangible assets, e.g., triggering their HY covenants.
Third, while netflix does expense their “Steaming Assets”, it expenses them at their contract price, not the value of the asset if Mark-to-Market were to apply. Thus, they’re able to “inflate” earnings artificially by expenseing lower costs than current market value of the expense should be, given subscriber base.
All this to say, apart from the problems mentioned above and by other comments below, Netflix is “having their cake and eating it too” raping mark-to-market on their single largest line-item based upon the assumption of limitless and exponential growth.
When this all does come down, the creditors will get basically nothing as the content “assets” cannot be called and redeployed or re-utilized (Congrats, you have the rights to Seasons 1-3 of the OC for the next 18 months. How do you get this right to customers for the next 18 months to realize the value the bankruptcy administrator has assigned you). The lease everything and apart from the “Netflix” IP, logos and some tech IP (which can be acquired elsewhere) — its a shell.
It doesn’t end well for anyone involved, but as long as this mania continues, seems like a completely sustainable business model.
Top quality content is so expensive and their ability to charge is so limited with today’s models. Netflix will need to diversify it’s sources of income.
Pure subscription services already died in the world of games which have a similar crazy high production cost to keep adding content. Howevery games have been able to add micro transactions to provide special content on top of the subscription.
I wonder if it’s possible for Netflix to figure out a new revenue stream based on special content. I think before long to survive they are simply going to have to diversify beyond just streaming movies and tv.
>Pure subscription services already died in the world of games which have a similar crazy high production cost to keep adding content. However games have been able to add micro transactions to provide special content on top of the subscription.<
There's a lot of pushback and controversy in gaming right now over the subject of "loot boxes" ie: extra paid content. Google or Youtube that term and you will see the controversy it's causing. It remains to be seen whether or not this will work out for the game developers.
Interesting. Thanks for the post. No discussion within the context of *assets* about *pricing power*. Does Netflix have *pricing power*? So far, several of its attempts to raise or tier its pricing have failed. A major *cost input* – proprietary content production – is a huge capital outlay, but its retail prices remain the same?
They are having a party while the ship slowly sinks, there are no rescue boats and no help will come.
“Kings today, paupers tomorrow, how Unicorns fake their way into success while scamming their investors.” Buy this book never on Wolf Street because no one has written it yet.
Nice post, HT. And to you too, Wolf, as always. One man and a few buds keeping up with ZeroHedge’s aggregation. Pretty amazing. Thanks.
The Key to ZeroHedge is to NEVER read the (poisonous) Comment section. Or just stick with Wolf.
Agreed! I can’t say I’ve followed that rule, but I usually regret doing it when I do read them. And it used to be so funny, Smart, informative, etc etc
Btw I’m an owner of a 7 or 8 yr old zero hedge T-shirt.
If I were doing the accounting for Netflix, I’d do the exact same thing. This is the Accounting 101 Matching Principle, no? Match revenues and expense to the periods in which they’re earned.
When you use a two year term, I’d use the Prepaid Expenses account instead of Fixed Assets per se. But it’s balance sheet nonetheless.
In terms of the cash effect in year one, that’s what the Statement of Cash Flows is for.
Please explain what’s non-gaap about their accounting.
Wilbur, agree that doesn’t sound like a problem but I’d like to hear more about the amortization of ‘assets’. If they are spending half or more of their gross revenue on proprietary content AND bleeding cash at increasing rates AND showing a profit for the year, then amortization seems like the place to find the real shenanigans.
Am not an accountant…is there a likely standard formula or can they make up their own weighting/timeline to write down?
Don’t get tricked by accounting terms like “Fixed Assets”, “Depreciation”, and “Amortization”. They only sound fancy.
If a company buys pens, it gets expensed and that’s that. It’s simply and everyone understands it. When a company buys a $10K piece of equipment that will last for 5 years, it’s called a “Fixed Asset”. Ooh! All this means is that the expense will be spread out over 5 years. So, this year’s income statement will show $2K in “Depreciation” expense of the asset as will the subsequent four years. All “Depreciation means is the amount of expense that’s being recognized from the fixed asset in a given period.
“Amortization” is the exact same thing, but tends to be for “Intangible Assets” instead of of “Fixed Assets”. For example, a patent is an intangible asset. But it’s the same concept. Let’s say a patent is bought for $10k and has a useful life of 5 years again. There will be $2K/yr in expense just as with the Fixed Asset. But instead of being called “Depreciation”, it’s called “Amortization”.
Haus’ example doesn’t really make sense. If an asset has a useful life of only two years, there’s really no need to call it a “Fixed Asset”. Furthermore, fixed assets don’t amortize. If it’s a two year deal, that’s really just a prepayment for next year.
Accounting is ridiculously easy. I take great pleasure in taking any false impressions of complexity out of it. (But keep in mind, the accountants’ lobby is one of the most quietly powerful in DC. This is why you’ll never actually see a major simplification of the tax code.)
Sorry, I’ll answer your question more directly this time.
The term you’re looking for is ‘useful life’. There are some general gaap and irs guidelines for the useful lives of certain fixed assets. For example, many people are familiar with the way that property can be depreciated over 27.5 years. Here’s an example of an Asset Life table:
Conceptually, the goal is to match revenues with expenses. If a piece of equipment will help produce revenue for five years, then its expense can be spread across 5 years, even if you paid $20K on day one for it.
The Netflix example sounds perfectly kosher to me. The have rights for two years to a product that will earn them revenues for two years. Then the cost should be spread out over two years. The end.
Thanks Wilbur for great info and great link too.
Your explanations are solid and you sound like a good guy who would use the powers of accounting only for good and not evil.
But…as Wolf states above:
“The way the company accounts for its spending on content production and acquisition – as an asset to be amortized over many years rather than expensed all at once – allows it to show a net profit even though it’s burning through cash hand-over-fist and expects to continue to so for as far as it can see.”
From the chart in your link, looks like Item 48.43 CATV Programming Origination is best match for Netflix assets. Standard depreciation time is 5 years. I don’t see any additional qualifications so can I assume that costs are expensed against assets at rate of 20% per year? This certainly can’t be considered reasonable. The demand for these old shows is going to be just as high 4 years from now while simultaneously competing with Netflix’s new shows?
So $5B spent this year is expensed as $1B and they’re still losing money (unofficially). If they spend $5B every year, year 5 will need to absorb $5B in programming expenses in a business model that isn’t working for $1B. And to keep math simple, this does not include increases in spending like $7-8B next year.
Think maybe normal-wholesome-standard-ethical notions you state like”useful life” and “the goal is to match revenue with expenses” may be clouding your vision ;) Thanks again.
This is still standard accounting practice for all sorts of assets. If Netflix pays $25m to show all Star Trek episodes for 5 years, the income statement should show $5m/yr in expense.
A lot of people confuse the Income Statement with the Statement of Cash Flows. Your Income Statement might show good performance or bad. But at the end of the day, don’t you want to have more cash?
So, in the Income Statement, Year 1 would show as more healthy because there’s only $5m in Expense. However, Cash Flow would show $25m down the drain. Then in Year 2, the Income Statement would show $5m in Expense again. But now, Cash Flow would show $0 for Star Trek.
Keep in mind that businesses would love to show a loss and be cash healthy. That’s the ideal scenario. How would you like $1m more per year and to not have to pay taxes? Netflix would love to expense all $25m in Year 1 because then their taxes are far less than if they only show $5m. But gaap asserts that revenues and expenses appear in the period in which they’re earned.
The Netflix problem is that it shows a loss and is cash poor. It’s a failing business model. It only survives by borrowing more which is the crux of Wolf’s piece. The cash issue is far more problematic than operating at a loss on the Income Statement.
By the way, the term “current” simply means anything that’s due within one year. “Noncurrent” means anything due in over a year.
A ‘current’ asset would be a receivable from a customer that owes you payment within one year. A ‘current’ liability would be a payment that you owe within one year. A noncurrent liability would be a payment that you owe in over one year or more.
i think their bonds are cheap, their equity is not.
but i have better things to do than loan 10 year money at 5%.
So do I.
A mix of silver, gold and US dollars – along with a few other misc bills – saved in mason jars planted in the back yard….
I’m sure that Netflix and it peers will feature in the next edition of Charles Mackay’s excellent book titled ‘Extraordinary Popular Delusions and the Madness of Crowds’. Now, where do I place an order?
Serious Question: How does somebody justify buying a ten year bond when the company can’t continue on it’s business model for that long? Is everything now a “greater fool” asset?
I am guessing they must think Netflix will raise prices at some point?
Standard plan will go up a dollar in November. I still think it is worth the money. Check out Mindhunter.
Netflix plan to disrupt Hollywood here: http://variety.com/2017/digital/features/ted-sarandos-netflix-original-movies-shonda-rhimes-1202527321/
I will gladly partake in using companies whose investors are subsidizing me. As far as investing goes…who the heck knows. I am not a professional gambler. ;-)
Mindhunter was good.
I dont get Direct TeeVee. 1/2 the content is infomercials and the other half has a ton of adverts. One station takes 3.5 horas to run a typical movie. HULU has some of the same contect for $20 a month versus $90 for Direct TeeVee.
“Abandon hope all ye who enter here”. Dante’ Inferno
At least one of the FAANG has no teeth.
Thank God the world dies for dollars else we would be as bankrupt as Venezuela with the bullshit going around this once mighty and productive nation.
Snapchat, Uber, Netflix, none of these companies make money. Yet some investors are shoveling billions into them.
I don’t even know what to ask anymore. It’s a mania.
More and more, it seems like a redux of the dotcom bubble of 2000.
When I look at Netflix, what I see is an HBO or Showtime paying for the rights to the old line networks (NBC, CBS, ABC, BBC etc.) serial programming after its first run is done. I think, ultimately, Netflix must be trying to get out from under the rights costs by streaming, eventually, nothing but original content.
I wonder if my experience is the normal for a subscriber- I started streaming from Netflix at the end of the Summer of 2016. At the beginning, there was so much to watch that I had never seen before, so for about 10 months or so, finding something new to binge was easy, but around this past June, I was finding that the new content each month to watch was increasingly difficult. If, for example, I found an old series to binge on Netflix, if the show was still running, I could just record the new season of it while they aired, while Netflix’s original programming still isn’t a whole lot of the fare available. By the middle of next year, I will probably only be watching the original content that I am interested in, and then the value of the subscription fee may well be diminished greatly to me.
That’s about my experience. Now, I pretty much only watch youtube. I still have netflix because women seem to like it. Almost all programming these days is oriented to women. The man is almost always a bumbling, unattractive dimwit, even in the commercials. One thing Trump is right about is most of the news is fake – not completely fake but so skewed by the desires of the owner and/or workers to be effectively propaganda.
Unfortunately, youtube has already begun demonetizing the content it’s owners/employees dislike, effectively censoring it. This will increase rapidly.
” I still have netflix because women seem to like it. Almost all programming these days is oriented to women. The man is almost always a bumbling, unattractive dimwit, even in the commercials.”
Their original stuff is easily forgettable though. Lots of chaff.
Their new Star Trek is terrible. I can’t fathom how they can clearly spend so much money but seemingly get it so wrong.
I’ve paid for Netflix since 2011 ish, and about £70/yr average.
Soon I’ll have spent £500+ on Netflix.
You can buy a lot of used BR or DVD in shops or Amazon, or just sale items new in shops for £500.
I’m setting up a decent media machine at home now and buying/ripping what I like to it and sacking off Netflix and anything like it.
I just hate the idea that I’m paying again and again for the same content, and the new content is gradually getting poorer and poorer (for my tastes)
Star Trek is actually produced by CBS but Netflix paid over the odds to get first dibs at streaming it. Reportedly they aren’t hugely happy about the quality
That’s very cheap though.
I’ve had cable for a good decade and I pay about $100 per month. Which equates to $1,200 a year, so since 2011 that would be about $8,400.
I only get it for live sport (basically one sport), and News to have on in the background, and maybe some movies now and then.
I think it’s great value. Would you agree?
I wonder if the old opprobrium about eating all the food on your plate, applies? There are media starved consumers in China who have no FB, be sure and post your likes every day, don’t waste one morsel.
“Their original stuff is easily forgettable though. Lots of chaff.”
House of Cards
Orange is the New Black
That’s just from the ‘drama’ category, but those all seem to be very highly rated shows. The only one of those I haven’t watched is Orange is the New Black, because I have no interest, but Narcos was excellent. House of Cards was excellent. Stranger Things was excellent. The OA was OK.
What dramas are you getting on cable that compare? I mean, without HBO/Starz/Cinemax etc.
“You can buy a lot of used BR or DVD in shops or Amazon, or just sale items new in shops for £500.”
You can get about 5 full-length TV shows on DVD for that price (new). Game of Thrones (seasons 1-6) costs almost $200. House of Cards is $105.
The cost is not even remotely comparable.
Orange is the new black was interesting a couple of seasons ago. The last one that came out on dvd was sappy.
The terrain for these produced shows is very competitive. New entrants are introducing new ways of story telling. Once up on a time, Homeland was new in its story and approach. Like OITNB, it has become very predictable. Narcos season one, was new fare. Season two, not so much.
For this reason alone (changing terrain) , keeping viewers interested is a losing game.
We have Netflix subsript. No streaming .. just ‘old school’ dvds .. couldn’t justify paying the increased fee. If fees are raised across the board, I will ditch the service altogether, and just buy whatever quality dvds I can aquire elsewhere … especially when there’s is so much unimaginative junk being produced.
Quality or Quantity is my mantra !
And as an aside .. this whole ‘alternate enterainment reality’ that has taken society by hyper-storm, first gradually … then all at once, will just hasten the demise of us all, as we’re being lulled into a continuously stupor, while the elites, with the help of their sycophants, rob & grift us blind !
Kenny Logins – you’ve just described my problem with online music. I can go to Fry’s and buy a CD of Louis Armstrong’s greatest hits and it’s 25 songs. I own the CD now. I can play it all I want. If my computer dies, the CD is still there. If I change ISP’s the CD is still there.
If I did online music, I’d have to pay $1 a song and more like $2 for the more popular ones. So now I’m paying $25. Then my computer dies and I pay another $25. Then I move and get a different ISP … $25 again to have those songs. I’m $75 in, and it’s not over.
500GBP spent in the library used book store, pawn shops, the swap meet, and Fry’s Electronics would get me a LOT of DVDs and CDs. Throw in Amazon, for that matter. I’d get to see movies I’d like to, but never have because movies in the theater are expensive. The Music Man. Disney’s Fantasia. That one where John Wayne is an airline pilot.
This is why I *never* fell for the Netflix scam. I realized back in 2005 or whenever it was when it came out, that how can they make money? It’s gotta be like the Columbia Record Club, which was always a scam.
To yancey Ward i have found that they are showing me more international films then ever before i think they now have the market on all indian and oriental films then ever before.I watched i indian movie and now have 3 lines of them.They now have every bad Nicholas Cage movie ever made along with Steven Seagal.Cartoons for kids are also out of control.They are still the best bet compared to HBO& Showtime they never change for months i stopped them years ago.Another big problem is the absolute garbage being put out by hollywood.
yeah, we’ve dropped netflix, too. we find our daughter is satisfied with youtube red and my wife and i are happier just paying ala carte from apple or amazon whatever other content interests us. we’d all rather web surf than channel surf…
Spotify is a similar case, even worse since they need less bandwith and don’t produce their own music:
The bailouts coming this time will make 2008 look like a walk in the park. How much you wanna bet that many of the big companies buying these bonds in this charade KNOW that when the shit hits the fan the bailouts will not be far behind.
heads they win, tails we lose. Same as it ever was.
I’m not so sure.
The bailouts in 2007-8 were seen by many as necessary to stave off an all-out financial collapse. If a second bailout happens, I think people will be irate.
Ironically, at the time I think many people hated Occupy Wall Street, and now I suspect in hindsight many people look back and think… gee… those young, idiotic hippies were actually on to something…
They can be irate all they want, rich and their puppets will do as they wish. They will laugh at the Occupy people in the streets, again.
You’re insinuating that people without wealth are puppets of the rich? It does seem that way for the most part.
“They can be irate all they want, rich and their puppets will do as they wish. They will laugh at the Occupy people in the streets, again.”
I guess I wasn’t clear enough in connecting the dots from anger –> violence. Society is already on edge, the amount of Americans who are struggling and increasingly have nothing left to lose is growing. That’s not a good thing. Leading up to 2007-08, things were generally considered ‘OK,’ and the GFC hit, and the proverbial caca hit the fan. Many, many Americans have never recovered. Many won’t, ever. If another crash hits and bailouts occur, after how well the top 10, 5, 1% have done since the GFC… I predict violence. That’s my point. That’s the point all aristocracies, all oligarchies, all semi-feudal systems (what we’re devolving into on a day to day basis) miss… when you take it too far, when you leave the peasants with nothing but crumbs, they will reach a point where they will forcefully change things.
In 2010, the richest 388 people in the world held the same amount of wealth as the poorest 50% of humanity.
In January 2017, the richest EIGHT people in the world held the same amount of wealth as the poorest 50% of humanity.
Today, the richest FIVE people in the world hold the same amount of wealth as the poorest 50% of humanity.
Whatever you want to call our economic system… it’s collapsing under its own weight. I’m not a socialist, not a Marxist… I simply acknowledge that without redistributive mechanisms, systems like ours concentrate wealth in the hands of fewer and fewer people over time, leading to an increasingly destabilized society.
Bailouts are already reserved for health insurance providers.
I can hardly wait for the supposed QE and interest rate increases over the next few months.
IMO wait of these companies are going to the graveyard and will ultimately have a value of zero with both shareholders and bondholders wiped out.
Some of the people that own large stakes in these companies have big fat heads and think that they are gifts to the world when in fact they really provide nothing of value.
All you have to do to figure out who these people are is to look at the Forbes list of the richest people in the USA.
Plus the wonder company Tesla……
Billions are going to be made from shorting the shares in these companies when the markets wake up.
Too bad that most people don’t have the necessary capital to short the shares in these overvalued pos.
The market will not “wake up.” The rich and institutional investors will panic for some reason and everyone will push for liquidity. Then and only then will these overpriced monstrosities face downward pressure on their bloated values. Right now, the idea is “if we all pretend these assets are over the moon, they are over the moon.” This Hayekian notion that there is some magic in this reified thing called a market, rather than simply the sum of the machinations of a bunch of greedy, interconnected insiders trying to game a system, is nonsense.
This. Banks create money when they lend. When they lend against assets, the prices of that class of assets increases. This market is a bunch of banksters and their Wall Street buddies creating and lending money to each other, driving up asset prices, and getting ever wealthier. This is how it’s been since before the Republic.
Only now their is no need to panic because they know the Fed will have their back when the Black Swan comes swooping in.
So the question is, who will save the Fed? $700 billion taxpayer dollars to save the New York casino last time. Is there a spare $5 trillion laying around to backstop the Fed?
Kam believe Wolf said recently that savers’ deposits are about $9t…CB injected $4t or so last several years.
The Fed has an infinite supply of money.
I hope you are shorting the hell out of these turkeys – Snap, Tesla, Netflix, Uber and all the banks – they are all going to get smashed 2018-2020.
People have been saying that for years now. People who specialize and make their living in shorting stocks have gotten crushed.
The market can stay irrational longer than you can stay solvent.
And that’s purely due to manipulation and who said it. If the law ever pertained to the big and powerful as it did to the small and weak, things would straighten out and the big shots would be brought back to earth.
Once NFLX changed business models from content “distribution” to “creation”, I knew it was the beginning of the end as the debt machine fired up – that was quite a while ago. I didn’t short it back then after speaking with a wiser friend of mine who told me to wait. “Don’t fight Wall Street’s darling stock” he uttered, over that last sip of Armagnac. The last few years have been sobering yet the time to pull the trigger is near.
And I notice you don’t mention interest cost on the bonds in their negative cash flow. Paying historical junk bond rates would probably double their negative cash flow rate. But this is now normal operation for many companies. And they can count on the Fed to keep the long term rates low. Your recent article on the compression of the interest rate curve demonstrates the Fed commitment to keeping long term rates low.
And I bet a lot of state and local governments are borrowing to meet cash flow, as well.
Interest rates may go negative during the next recession (and remain negative indefinitely) because there is so much capital looking for a yield and nobody wants to borrow.
If that happens it is possible to ban interest so that irresponsible lending will stop. Junk bonds yielding more than zero can’t be offered by then.
OR so much capital is destroyed in the coming crash that the interest rates rise.
I see the coming crash as being epic.. Meaning many leveraged companies will go out of business and those holding the worthless paper will never get repaid. Thus trillion$ vanish. There is just to much leverage to be repaid out of actual income. The crash will destroy income too making matters worse.
Those in charge want you to believe in the fantasy of negative rates so you’ll put your money in risky investments as in bond funds. We all know that much of this debt can not be repaid already so where is this capital going to come from?
It is an old scam.
This is the EXACT same scenario as ENRON…
So what’s the secret? Netflix’s stock price.
Just like Tesla and some other companies that are bleeding cash in vast and never-ending amounts, their overinflated stock price acts as a guarantee – in the bondholder’s mind which has been bludgeoned by central banks – that the company can always sell more shares to raise the funds necessary to deal with its debt and cover its negative cash flow, and that therefore the risk of default is small.
– Netflix had to pay “only” 256 basispoints more ???? It shows how investors are still “chasing yields”.
Remember when fundamentals mattered, before the central banks embarked on QE-to-Infinity?
Nobody even cares anymore about any kind of realistic evaluation of businesses and their worth.
What is Netflix’ competitive advantage? How can it produce more cheaply or charge consumers more for its products than others in the same business? (hint: it can’t and thus doesn’t) What are the risks and threats? When I ask these questions, I can’t come up with answers that lead me to their current valuation. It’s not that Netflix is bad or anything, not at all, it’s just not worth what people seem to think it is. And that assessment leads Netflix down the path of inefficiency (after all, it is more important to be efficient i.e. have high margins when your cost of capital is higher).
The same goes for most of these guys. AMZN, a company in a traditionally low-margin space but with “cheat codes” that enable(d) it to dodge tax (government subsidy). TSLA, another high visibility example of a company that does not make it without government intervention. There’s a lot more that you can name here too.
It’s worth wondering if there is anything left at this point that has not become so inefficient that it can survive without cheating (and is fairly valued).
At some point something is going to go bankrupt that shouldn’t. and then this whole thing will cascade. Without a cash burn this large, Netflix would be perfectly viable as a moderately profitable enterprise. However, it (imo wrongly) thinks it has a competitive advantage and growth potential (that’s big enough to support stratosperic P/E multiples) in content production, while its only advantage, historically, is in media distribution (and always has been, since before their big metamorphosis). A lot of businesses big enough to feed from the trough of central banks will find themselves in a similar predicament.
Good reply Julian.
What I don’t get is if all the people on here can see the business model isn’t right then why can’t the markets and financial programmes on TV see that also?
Because in essence between delusion , greed and PDVS ( post decision validation syndrome ) they do not want to see it .
Nail on the head. Without direct or indirect government subsidies, or close proximity, socially or geographically, to the Fed, most of the largest U.S. corporations and banks would fall prey to competition.
U.S. government policy has been to support the Dinosaurs while stepping on the throats of small and medium size businesses. Same as it ever was, the best return on investment is buying political power. It’s not fair, it’s not right but it will continue until the country cannot afford to subsidize the walking dead.
Julian, as you can see, we have two different Julians here in this thread, and more overall. This makes it confusing for everyone. From now on, could you add a letter or number to “Julian” to make it unique? Thanks.
“At some point something is going to go bankrupt that shouldn’t.”
This interesting article begs the question of what Netflix theoretically should be charging its customers to operate on a profitable basis (by traditional standards).
Also, there is the question of Netflix’s own long-term strategy. Is Netflix expecting certain of its competitor models (traditional cable, premium cable, or other) to become less competitive?
I hadn’t thought of this angle – perhaps that’s a good part of the drive into original content. Traditional cable companies look to be in a terrible spot and trending downward.
With television shows, I’m told the licensing is a nightmare. Old shows have music and other bits that have to be licensed along with the shows, so there are lots of rights holders that all have different terms and conditions.
I work for one of the not-yet-profitable internet media company things, licensing is a huge hold back.
I’m sure the Netflix in-house creations obviously get them around all the license non-sense with older shows and huge price points. No idea how much Netflix is spend in making their shows versus major networks, but they have something they can license out forever. I assume they still have to go through SAG for talent. The comedy productions that see to plug up my Netflix screen are probably super cheap to produce.
This is akin High Net Worth individuals pledging their stock to borrow money. At least Netflix is not buying its own stock yet with their cash.
Netflix is doing what creditors and stockholders encourage it to do. That’s the irony.
You really can’t blame Netflix. You have to blame the stock market and the bond market … and by extension, the chase for yield that causes these distortions and the blind craziness taking place in equities.
Wolf, outstanding article. Thanks.
We’ve had Netflix for a few years. Coupled with an amlified antenna that allows us to get network channels for free (that’s about all they are worth though).
We’ve use up all the Netflix content. Now we’re on Amazon since we have a Prime membership (last one). We’re using up that content as well.
What we’ve noticed is these dark cop series seem ubiquitous on both venues. And they are getting more and more weird to the point where we won’t even watch them. But it’s clear they cost alot of $$ to produce.
Netflix recently announced a price increase. Haven’t seen it yet but will probably cancel. Same with Amazon. But among our late 50’s friends, these venues have become sort of a mecca for hiding away from the world with these binge watching series. So for now, I expect things will continue for them.
But I expect things to continue to worsen for the the 90% to the point where even a $15/month subscription will be questioned by many as frivilous.
Not buying the circular logic, the stock price probably has little or nothing to do with the junk bond holders, and is probably the least vulnerable component. Stocks only go up. Their media model is to group junk “media” in tranches, you buy 100 shows you only watch 2 or 3. This is the failed cable model but it is a proven business model. Pay for view entertainment appeals to the proven demographic, teenagers with discretionary income. Original content? Probably not. Nothing here is original which is why investors love it, they recognize the company, the product, the service. The junk bonds are rated at par with Treasuries because there is nothing here to worry investors one bit. Its finance in syndication. GILLIGAN!
NFLX business model is really rather simple
World wide subscription revenue-content costs -administartive costs-capital costs=profit.
But there are too tiny problems with this model
1.It is dependent on revenues from developing countries to spike its future revenues,since growth in the developed countries is mature.While China has the biggest potential ,it is also the least likely to provide significant revenues,because of censorship issues and China’s dislike of foreign internet companies. FB is currently blocked in China.
India ,the second largest in population has a myriad number of cultural issues which make it unlikely to be a large source of revenue within the next 5 years
2 .There are a number of well heeled competitors.AMZN.AAPL,GOOG among them
3. Its content costs keep on escalating .NFLX hope is that their home grown content does not get stale and can be used for a number of years,so it can used over a number of years.
AS others have pointed out NFLX plays games with its accounting , especially in he way that its amortizes its content costs.
To be fair, NFLX stated that they were going to to be cash flow negative for the foreseeable future.
Serialized dramas go stale quickly. How could they possibly generate significant revenue years out?
Unicorns aren’t “too big to fall”.
Twitter is gone? People will just move to a similar service. Facebook crashes and burns? Google will make a clone in less that a month.
Amazon is gone? Google again.
Google is gone? Well that one might get a rescue.
So how long until even yahoo mail service is gone?
Netflix need to spend it’s money wisely.
Maybe Netflix needs to purchase something tangible.
According to accusations from the Australian Labor Party –
Prime Minister Malcolm Turnbull’s Liberal Coalition Party wants to sell of the ABC Network ………..
And especially after the latest 4 Corners program titled – What’s wrong with the NBN?
The Australian ABC Network are a national media network payed for by the Australian government. Their work is exemplary, they have been a thorn in the side of many a mainstream mogul over the years – so it is not likely that mainstream is interested in purchasing but shutting down the ABC Network.
There are whispers that cashed up alternative media interests are looking at the ABC Network as a way into “growth & respectability”.
There is no reason for Netflix to have money problems – it must be the financial advice that they are paying for that’s ROTTEN – get rid of them man.
I’m really confused. There are these analysts, paid richly for their stellar analysis.
24 recommend buy, 3 are overweight, 13 recommend holding Netflix and only 3 recommend selling.
No reason to be “confused.” That’s just how it works.
I just saw this great chart in the WSJ about GE’s stock, which has plunged about 35% since summer 2016, and analysts’ “consensus” price targets, which have consistently lagged the down-moves, and every step along the way were much higher than actual. But the curves where nearly parallel – just offset by the time lag and the much higher prices. These people are a joke :-]
Analysts don’t trade– for a reason.
And depending on how likely you are to buy into conspiracy theories, some would argue that despite laws and regulations separating trading from sell-side research, you’d probably find some very coincidental trades from banks and investment houses that run contrary to their sell-side research. In other words, they may be telling clients to ‘buy’ (or ‘hold’) while their traders are selling.
That being said, the analyst reports themselves can often have good information in them, but the price targets should generally be ignored. There’s no practical basis for turning some fundamental information– no matter how good– into a specific price target with a specific time horizon. Markets don’t work that way.
Netflix has yet to exploit the opportunity to sell advertising on its content. The last time I went to the movies, it was half an hour of previews and ads. I wouldn’t mind just one ad per movie or episode on Netflix.
Their original content is among my least favorite selections. I spend my time mostly watching foreign films and serial dramas. I am fascinated by the selections from places like Russia, Turkey, and the Middle East. You never get a chance to see anything like it on cable. If they lived streamed a news show like Bloomberg, it would be perfect. As it is, I am going to be dropping cable when my contract is up.
There is only so much advertising you can put in a product before you start losing customers. Take a look at Internet ads, many sites are going by “see this ad before you can see the content you want” format because is the only way people will pay attention to the ads. “Unskipable” ads in DVD and Blue ray gets skipped by players that can skip them or by people just muting the TV until the ads are gone.
Netfix is a paid service, if they put too many ads on it then people will move to a service with less ads. Just like people with Cable avoid channels with too much advertising.
Take a look at Netfix numbers in red, Netfix days are numbered. The moment it cannot get more credit is the moment the company will die a painful dead.
I do laundry or make a meal during the commercials on tv. I can literally complete an entire chore during a commercial break. The advertisers are wasting their money on me. I would be a lot happier if they lowered their prices instead.
The ads on the internet only bother me because there are so many. I use an ad blocker because on some sites it takes a long time to load the page, while they are auctioning the space. Sites that only sell one ad and load quickly are fine with me. If more sites did this the price of their real estate would go up for all of them, and the experience would improve as well.
I understand that the advertising revenue for the last election was over 2B on tv mostly. This was completely wasted money. I think everybody can see that now. The only political ads I watched were replays on “news” shows.
I would watch one ad on Netflix if it meant keeping the prices down.
Petunia – I’ve used TV commercial time to exercise, me + dumbbells/barbells + TV + commercials has always resulted in me adding some serious muscle.
I don’t have a TV now though because I don’t want to use any more electricity than I have to; a TV might add as much as $15 a month to the bill and that’s a lot of money.
Netflix & other similar organisations need to realize that their customer base is in the incompetent hands of governments of the world.
Customer access to a reliable NBN setup is imperative to Netflix bottom line.
The roll out of NBN in Australia should have been as efficient as that of NZ.
How did the Australian government screw it up so badly ?
Did they think that only they & the corporate & banking dynasty’s required top quality & speed online & the rest of Australia could go fly a kite ?
They most likely feel that businesses like Netflix are a novelty – like Sunday lunch at mom’s house.
But it is not just Netflix that is stunted by the backward & tightfisted mind set of an uninspired government, who is loathed to spend monies on necessary infrastructure.
Some day, one day it a day to wait for.
Netflix is not great at curating critically acclaimed content – unlike the free criterion films streaming from your local library or FilmStruck if you’d prefer to pay. Also 30 Rock is gone so whats the point of anything.
i used to work at a&e networks (disney/hearst). they’ve learned the hard way that you have to make the right kind of original programming. their lifetime channel was built on “unscripted/reality” programming. well guess what? nobody watches reruns of that stuff. their history channel which was considered uncool because the demographics were older is actually the cash cow because you can repackage the same old ancient aliens, etc. for ever. meanwhile they are rearranging deck chairs on the titanic…
As a retired teacher I have to object to a Channel called History marketing so much utter tripe, which is actually anti-history.
How were the pyramids built? Aliens built them. How did they move the stone blocks? Anti-gravity.
I’m not making this up, that was on one episode.
Erich Von Daniken, who began all this stuff with Chariots of the Gods has admitted his stuff is fiction. He maintains that is how you spin a good yarn, by pretending it’s real.
Fine, I like a yarn too. The classic ‘Treasure Island’ reads like a documentary. It says it can’t reveal the exact location of the island because ‘there is treasure not yet lifted’
But ‘Treasure Island’ is found in the Fiction section, not the History section.
Briefly, the channel had a few episodes of something about ‘power nodes’ extending down into the earth. This show and the female host turned out to be too much even for the BS merchants and it disappeared.
Moving on from the lunatic strata to just plain rubbish, is ‘Hunting for Hitler’, which explores his supposed flight to South America.
The last days and hours of Hitler are very well documented by many very credible witnesses, who had nothing to gain and their lives to lose by lying, e.g. Albert Speer.
Not just kids but especially kids rely on TV for a lot of what we used to call basic knowledge, a rapidly disappearing critter. How can you expect them to have a clue when you have adults feeding them nonsense?
I’m not advocating censorship, just don’t label fantasy as history.
No worries. Netflix will acquire Time Warner (they really do ring a bell at the top), short sellers will be carried out on stretchers and wall street and the media will bloviate on the merits of the deal and applaud the synergies.
“No worries. Netflix will acquire Time Warner”
Do you know that AT&T is at the cusp of merging with Time Warner?
There you go. Time Warner is being acquired. The bell is ringing. The top is in.
Not quite. If you are looking for aol time warner kind of merger, your original idea of Netflix buying at&t-time Warner will make the narrative twice as interesting, not to mention different. And you will have heard two bells, such as the ones they ring when dinner is served.
AT&T buying time warner is just another old news of boring industries buying and selling each other.
“It just doesn’t charge enough to cover the expenses. In other words, investors are subsidizing the subscribers.”
Well I can speak from experience, if Netflix charges anymore than the 9.99 per month I’m currently paying, then I would dump the subscription in a blink. Get an Android box and get all the shows u want for free, for example. Cable TV is dying and it is only a matter of time before these payed streaming services will follow suit.
there was a study done( can’t remember who) that when a subscription service gets over $14.95 per month there’s problems. They could price it at 5 bucks and I’d pass.
In the past, before the dawn of QE and the post-modern stock market, companies would occasionally fall off the indicies such as the S&P and the DOW. I remember the bankruptcy of Kodak, once a Dow giant.
Now that all of this new money goes straight into “assets” like S&P 500 ETF’s, it seems to lock the biggest companies in place as they always have a hungry market for their stock, regardless of internal operations.
I keep telling myself it can’t last forever, but then again the BOJ has been into easy money since their 1989 crash, so “zombie-businesses” may just be the new normal.
There is a lot of money floating around.Unless there is a major
catalyst ,like the U.S. gov’t having difficulty borrowing funds,
this will continue.
Netflix: $9.94 to $192.47 in 5 years. A 1900% return for a company operating at a continuous loss.
A Market Game Theory
Imagine the market as a table with trap doors. All of the players have a vested stake in the center pile. A player can pull his trap door at anytime. However, if he pulls it to soon and nobody else does, the re-entry cost will exceed the exit price. If he pulls the trap to late his exit is less than his entry price.
So now we are in the show down phase with each trigger ready player looking at an enormously over valued market. And let us not forget some of the players are highly leveraged.
Given these conditions one might be temped to believe the penalty for an early exit is only missed opportunity. In fact one could believe an early exit only requires one patiently waiting for a favorable entry point. This strategy has historically proven successful.
But are we now living under a new paradigm. June 2017, Fed Chairmen Janet Yellen made her famous ‘not in our lifetime’ statement. That is an exceptionally long range market prediction! Of course she immediately walked back from it… ;]
If anyone truly believed that Yellen was serious about raising rates we wouldnt be talking about this. The Fed has truly become a walking joke.
Is it true that Netflix content is hosted on Amazon Web Servers? If so, isn’t it inevitable that Anazon just buys them? They’re attempting to monopolize everything else including shipping, right?
My daughter dragged me into one of Amazon’s new retail stores. Sure enough, all cellular service was blocked upon entrance. Absolutely disgusting. The nerve, of all companies.
(By the way, in terms of pure writing skills, this is one of your best pieces. Precise and fully coherent. Well done.)
Yes, Netflix is hosted on AWS. Occasionally, the AWS system goes down, and a lot of sites of big companies that host their content on it go down too. The last time this happened in February 2017, I think Netflix came out untouched. But a big AWS outage in 2015 caused Netflix to go down too.
AWS controls about 40% of the “cloud” globally. Even arch-competitor Wal-Mart is using them, though they’re now trying to pull out. I imagine that Netflix too is trying to distance itself from AWS since Amazon is a competitor.
Yes, Amazon is trying to monopolize whatever it can.
Netflix is trying to be the Amazon of media.
The problem obviously is that Amazon is ALSO trying to be the Amazon of media ;)
And judging by some of their recent productions such a Man in the High Tower they are doing a pretty good job of it.
And then you have Hulu, Apple, Comcast and half a dozen others trying to do exactly the same thing.
Perhaps the most surprising irony in all of this though is that given all of the competition in this arena the quality of content is truely amazing. We are living in the golden age of (on line) television in terms of the quality of the shows. That they are spending super tankers full of money clearly shows in the production quality.
It can’t be sustained of course and the shake out will be painful but enjoy it while it lasts. Peak binge watching here I come ;)
Just think about Netflix going out of business. All of those red and orange Netflix buttons on millions of remotes; and all of those millions of built-in Netflix apps on billions of TVs, disk players, media players, etc. will all become useless. All of those content producers all over the world will no longer enjoy Netflix’s money the instant Netflix pulls the plug.
Many millions of spoiled, STINGY people (voters!) will all scream in unison “something must be done!”
But something CAN be done. Netflix has to jack up its subscription rate to some multiple of what it is now.
Wolf, you’re an expert at this sort of thing. Tell us what Netfix’s monthly subscription rate would have to be in order for Netflix to make a real profit.
Just ball-parking, I’d say at its current level of spending, it should make an additional $2.5 billion in subscriptions a year. And/or, as has been suggested here, it could start selling ads. But people don’t like higher subscription costs and they don’t like ads, and the treadmill Netflix is on might start screeching. It did raise its subscriptions the other day, but I don’t think that was nearly enough.
According to CNN, Netflix supposedly had around 100,000,000 subscribers in April.
If your $2.5 of additional revenue in order to have a real profit is close to the mark, if my math is correct, all Netflix has to do is raise their subscription rate to those customers by “only” $25 per month.
Or maybe Netflix could have two subscription rates — one with ads and one without, but “whatever it takes” to maintain our contemporary nirvana of forever blowing, forever growing bubbles must be done!
My math was indeed wrong, so I must correct myself, Wolf said $2.5 billion per YEAR, or $208.3 million per month. So also divide my $25 by 12 and the result is around $2.08 per month.
Sorry about that.
Even that hike might cause it to lose some subscribers. When Netflix reports declining subscriber numbers, its shares get hit hard. So it will be careful.
To all fellow Wolfers – how do we profit from this madness?
This is my 2nd attempt at seeking PRODUCTIVE feedback,
I am sure we all dont want to be just bitching about how the system sucks which while true doesn’t help anyone.
If someone wants to collaborate on brain storming mail me -pls: firstname.lastname@example.org
Surely many of us will jump at the chance to “brainstorm” with some random dude on the Internet who posts his personal e-mail address.
There are plenty of forums where you can probably link up with like-minded “thinkers” if one is so inclined, but I would submit this isn’t the forum for that kind of activism, where the motives, intentions, and judgement of the poster might be open to question.
I will post an article touching on your question, citing Einhorn who has tried and failed to profit from this madness. It’ll be up shortly :-]
Investors are betting that the government will do nothing about monopoly power.
That’s the bet of Uber, Netflix, and Amazon. They will kill the competition by selling at a loss. Investors ar
e (apparently) betting that the gov’t will let this happen and some sunny day these companies will jack up their prices.
Investors are betting that the government will do nothing about monopoly power.
The Republicrat duopoly is on the make and on the take, acting as the political adjuncts of its Wall Street and corporate donors and their lobbyists. With the institutions of governance captured and co-opted by these grifters, it’s a safe bet no one in government, especially “our” complicit regulators and enforcers, will left a finger to check monopolies or predatory capitalism or look out for the public interest.
Congressman Billy Tauzin started his career as a Democrat, switched to the Republican party, played a major role in crafting the horribly expensive Medicare Part D drug benefit for seniors program (Medicare was prohibited from bargaining for lower prices from the drug companies) and finished his career as head of Big Pharma where he was paid millions of $ over 5 years. You can read more about him by doing a Google search.
Of one thing I am certain….
Unless a monopoly is supported by government it cannot survive. The older they get they tend to get bloated and become complacent.
The gross profits they make are a open invitation for competion to rear its head. The ensuing competition is lean & mean and will have the latest technology for the job at hand. The “monopoly” will suffer a certain death at the hands of their new competitor.
I know this to be a fact as I have entered monopolistic markets on three occasions – and completly drove out the old guard – one of which was a Korean firm.
Post-crash historians will marvel at the sheeple for their passive acquiescence at the collusion between the central bankers, Wall Street grifters, and captured regulators and enforcers that led to the most colossal asset bubble and subsequent global financial crash in human history.
We will not have honest markets or sound money until we audit the Fed, then end it, holding its officials fully accountable for any financial malfeasance uncovered.
It is an alias Gershon.
And the intent is genuine, I hope you don’t use your primary email to post comments here:)
I don’t doubt your sincerity, but I’m a lot less interested in “profiting” from this madness, as you aptly put it, than I am in mitigating, to the degree I can, the economic carnage that is going to ensue when the central bankers’ financial house of cards comes crashing down under the weight of its own fraud and artifice. And while people can “brainstorm” all they want, the fact is that financial chicanery, not fundamentals, are what is moving these markets. I have no inkling how to brainstorm how to “profit” from that, nor would I even attempt such a thing.
As a former above-the-line worker in Hollywood my takeaway is what boom times for that business, that is, the individual freelance (per se) workers. All that money on original scripted content is going somewhere. Writers, directors, actors, DP’s, etc. If you’re not getting steady work now, give it up. You never will.
Excess liquidity can keep inflation low!
Central bank generated liquidity makes low prices possible by keeping unprofitable business alive.
When talking about too much liquidity, most people think about the effects on demand. However, there is an obvious effect on supply, through the financing of unsustainable capacities.