Thoughts on Netflix's earnings report; The story of how I started my hedge fund; Charlie Rose interviews Warren Buffett; My cocktail party in Omaha in nine days
1) Streaming giant Netflix (NFLX) laid a goose egg when it reported first-quarter earnings yesterday after the close...
While it only missed analysts' revenue estimates by a hair – $7.87 billion versus $7.93 billion – it lost 200,000 subscribers during the quarter (the first time this has happened in a decade), versus the company's own guidance of a gain of 2.5 million. Worse yet, it guided for a further loss of two million subscribers this quarter.
No wonder the stock is getting creamed today.
My colleague Berna Barshay and I have been discussing it internally and I wanted to share her thoughts:
Netflix is largely a victim of its own success here.
Management said the headwind of the great pull-forward of subscribers in 2020 is over, but I think there is still a good bit of COVID-19 hangover here. The giant pull-forward was the reason I was so bearish on the stock in late 2020 and 2021. When I flipped positive on it three months ago, I knew that, at $300 per share, the stock wasn't a bargain... but in the past I have found that if I wait for a true value price on a clear growth leader, I end up missing it entirely 90% of the time.
Netflix is also a victim of its own success because it was so consistent with growth for so long.
As I have written about extensively in my free Empire Financial Daily e-letter (which you can sign up for here), Netflix has likely hit saturation in the U.S. and Canada, as well as in the more affluent European markets where it has had a presence for a long time now. Growth going forward is coming from consumers in developing economies – whether in the EMEA region, Asia, or Latin America. Food and energy inflation packs an extra kick in these lower-income countries. It makes you wonder where the next axe will fall when it comes to lower- and middle-income consumers pulling back...
I know a lot of people are focusing on growing competition and content quality, but if you look at engagement and subscriber growth, the only market player that really made big inroads in 2021 was HBO Max. And that came at a great opportunity cost, with the move to drop all their major film releases last year onto the streaming service on the same day they hit theaters.
While there is a lot of low-quality dreck on Netflix, lots of people enjoy watching that dreck. And there is no shortage of prestige shows and water cooler shows to captivate audiences.
The competition for time and attention was always there – first from linear TV and video games and now increasingly from other streamers and short-form video social media.
But I don't think anything has materially changed in the industry... This is the same company that we were applauding six months ago for its global triumph with Squid Game and that has been giving prestige TV incumbent leader HBO a run for its money at the Emmys for years now.
We're looking at a seismic sentiment shift, and this is impacting the valuation. But the long-term outlook for streaming overall – and for Netflix – is unchanged. Fast-forward 10 years and streaming will have grown and linear will have shrunk. And Netflix is still the leader in the industry by a large margin – by subscribers, the amount of content produced, name recognition, and management competence and quality.
The problem is that the stock didn't have a margin of safety at $300 per share for the next bad data point, which is pretty much a knock you could make about every tech high-flyer whose stock is down. This is just another one that was down but not dirt-cheap, so it was exposed to another leg down on the next disappointment, which is what's happening today...
That said, I think Netflix is much further ahead than most other fallen tech companies in proving out its business model. I was encouraged that management, for the first time I can remember, articulated an interest in protecting the operating margin and not just trying to spend their way out of the problem.
Management also indicated on the call that the company will crack down on password sharing, something it has been quietly testing recently. There has always been low-hanging fruit here – but until now, growth had come so easily that Netflix hadn't bothered to plug that hole. The fact that the company is finally getting to this now indicates the growth headwinds are very real – but I do think it's good that Netflix is doing this.
I had been expecting the company to eventually explore the possibility of a lower-priced, ad-supported tier. This is a big trend in the industry and a major opportunity. I knew Netflix would do it eventually, even though it has been extremely reluctant to go in this direction for years.
But the consumer is asking for this – and major competitors are all offering it or planning to soon, so I think it is encouraging that Netflix is willing to be flexible and react to changing consumer desires, and not sit on this issue any longer. I expected the company to get to this place soon – but not on this call. Good for management for keeping an open mind in terms of strategic direction.
Just as sentiment was too bullish on this company for a long time, I think it's too bearish now... which is why I think today is a great opportunity for long-term investors who can tune out the noise around this stock for the next few quarters (or possibly even a year or two).
I think investors who buy at today's price will be rewarded, but they're going to need some patience here.
My take: I agree with Berna. I have no opinion on where the stock goes in the next few weeks and months, but I think it's highly likely to outperform in the next one to three years.
2) In yesterday's e-mail, I shared a story about two students who dropped out of Harvard in 2016 to start a hedge fund, which is doing quite well, with $665 million under management.
While I applauded their entrepreneurial spirit, I also cautioned:
I would argue that what Ms. Shang and Mr. Haigh did was extremely risky to the point of recklessness. If one of my daughters came to me with this hare-brained plan, I would absolutely forbid it (not that they'd listen to me!).
Just because you can start a business doesn't mean you should.
I speak from experience because, even though I didn't drop out of college to do so (I was 10 years out), I now realize that I never should have started my own hedge fund back in 1999.
Yes, I was a combination of smart and lucky (more the latter) and had a great run for the first dozen years, growing from managing $1 million on a laptop on a rickety Ikea desk in my bedroom to managing more than $200 million and appearing on CNBC regularly and 60 Minutes twice...
But then my lack of proper training and experience caught up with me and I made a series of mistakes that ultimately led to mediocre performance over seven years that led me to close my funds.
I'm writing a book about this called The Rise and Fall of Kase Capital, which I'm going to finish one of these days (it's 90% of the way there)...
Here's an excerpt that describes how I first got into investing in the late 1990s:
My wife Susan and I got married in 1993. Even though my job with Professor Porter wasn't earning me anything like what my HBS classmates were making, Susan had a good salary as a lawyer, and we lived frugally. So after a few years, we finally paid off my business school debt and saved our first $10,000. I thought I was rich!
I wanted to invest this money, so I called my college buddy Bill Ackman. He's now the world-famous billionaire manager of hedge fund Pershing Square Capital Management, but back then, he was running his first, much smaller fund, Gotham Partners. I asked for his advice and remember exactly what he told me: "Read everything Warren Buffett has ever written. You can stop there. That's all you need to know."
I took his advice and was immediately hooked. Buffett's idea of trying to buy dollar bills for 50 cents immediately resonated with me because my parents knew how to squeeze a dollar until it screamed. We rarely went out to eat, only bought used cars, and shopped for our clothes at thrift stores.
I continued reading everything I could by (and about) Buffett and started attending every Berkshire Hathaway (BRK-B) annual meeting. Soon, I felt confident enough to start buying a few stocks.
To my delight, most of them went up – some by a lot! I remember investing the entire $20,000 in my wife's retirement account in AOL's stock in late 1997 and watching it turn into $120,000 a year later. Making $100,000 so quickly blew my mind!
I soon came to believe that I was God's gift to investing. That's what making some quick money will do. (Plus, I was pretty full of myself, with my fancy Harvard degrees and all.)
But in truth, I now realize that I was, as the old investing adage goes, confusing brains with a bull market.
In reality, I had gotten lucky and stumbled into the last blow-off phase of the long bull market that started in 1982 and ended with the insanity of the Internet bubble 17 years later.
I'll continue this story and the many lessons I learned in future e-mails...
3) Speaking of Buffett, Charlie Rose just posted a recent 74-minute interview with him, which you can watch here. Here's a summary: Charlie Rose Returns: Fired CBS Anchor Interviews Warren Buffett Four Years After #MeToo Scandal. Excerpt:
Four years after being fired from CBS amid sexual harassment allegations, Charlie Rose has reentered the public eye via an extensive interview with business magnate Warren Buffett.
The interview appeared this Thursday on Rose's personal site, which also features archival interviews he conducted during his time as a CBS news anchor. On the homepage of the site, Rose notes this is the first interview he's done in over four years, and implies that this will be the first of several independent interviews he will conduct...
Rose's interview with Buffett does not mention any of the allegations that ended his terms at CBS and PBS. The hour-long conversation instead focuses on Buffett's career as chairman and CEO of Berkshire Hathaway, the Omaha, Neb. conglomerate that owns prominent companies such as GEICO, Duracell and Dairy Queen. During the interview, Rose also asked Buffett, the fifth-wealthiest person in the world, his opinion on other prominent multi-billionaires, including Jeff Bezos and Elon Musk.
Here was one of my favorite lines about his first investment at the age of 11:
I put my entire net worth of $114.75 into three shares of Cities Service Preferred. Since that day, March 11, 1942, I have never had less than 80% of my money in American business (you can call them stocks, but I see them as American business)... I don't want to own anything else.
4) Speaking of Berkshire, its famous annual meeting will be held in person for the first time in three years in Omaha, Nebraska, on Saturday, April 30 – only 10 days from now.
I will, of course, be attending – my 25th in a row! – and will once again be hosting my annual cocktail party from 8 p.m. to midnight the evening before the meeting, Friday, April 29.
It's free and open to all: no agenda, no speeches, no dress code. Just come, enjoy the drinks and snacks, and meet other investors. And if we've never met, be sure to introduce yourself!
It will be in the St. Nicholas Room (2nd floor) at the Hilton Omaha, right across the street from the CHI Health Center, where the meeting is held.
You can RSVP for it here.
Best regards,
Whitney
P.S. I welcome your feedback at WTDfeedback@empirefinancialresearch.com.