Mad Hedge Technology Letter
April 18, 2019
Fiat Lux
Featured Trade:
(NETFLIX’S WORST NIGHTMARE)
(NFLX), (DIS), (FB), (AAPL)
Posts
Netflix came out with earnings yesterday and revealed guidance that many industry analysts were dreading.
It appears that Netflix’s relative subscriber growth rate has reached the high-water mark for now.
Competition is rapidly encroaching Netflix’s moat.
In a letter to shareholders, management opined revealing that they do not “anticipate these new entrants will materially affect our growth.”
I am quite bothered by this statement because one would have to be blind, deaf, and dumb to believe that Disney (DIS) or Apple’s (AAPL) new products will not take away meaningful eyeballs from Netflix.
These companies are all competing in the same sphere – digital entertainment.
Papering over the cracks with wishy washy rhetoric was not something I was doing backflips over.
Netflix’s management knew this earnings report had nothing to do with results because everyone wanted to reassess how bad the new entrants would make life for Netflix.
Disney has the content to inflict major damage to Netflix’s business model.
The mere existence of Disney as a rival weakens Netflix’s narrative substantially in two ways.
First, Disney’s entrance into the online streaming game means Netflix will not have a chance to raise subscription prices for the short to medium term.
The last price hike was done in the nick of time and even though management mentioned it followed through “as expected,” losing this financial lever gives Netflix less ammunition going forward and caps EPS growth potential.
Second, another dispiriting factor is the premium for retaining and acquiring original content will skyrocket with more firms jockeying for the same finite amount of actors, producers, directors, and writers.
This particular premium cannot be quantified but firms might try to bid up the cost of certain talent just so the other guy has to foot a bigger bill, this is done in professional sports all the time.
Firms might even take actors off the table with exclusive contracts just to frustrate the supply of content generators.
Uncertainty perpetuates with the future cost of content unable to be baked into the casserole yet, and represents severe downside risk to a stock which trots out an expensive PE ratio of 133.
Growth, growth, and more growth – that is what Netflix has groomed investors to obsess on with the caveat of major strings attached.
This model is highly effective in a vacuum when there are no other players that can erode market share.
Delivering on growth justifies heavy cash burn, and to Netflix’s credit, they have fully delivered in spades.
The strings attached come in the form of steep losses in order to create top of the line content.
Planning to revise down annual cash flow from $3 billion to $3.5 billion in 2019 will serve as a litmus test to whether investors are ready to shoulder the extra losses in the near term.
I found it compelling that Disney Plus will debut at $6.99 per month – add that to the price of Netflix’s standard package of $12.99 and you get a shade under $20.
Disney hopes to dictate spending habits by psychologically grouping Disney and Netflix for both at under $20.
The result of breaching the $20 threshold might push customers into ditching Netflix and sticking with the $6.99 Disney subscription.
Then there is the thorny issue of Netflix’s growth – the quality and trajectory of it.
The firm issued poor guidance for next quarter projecting total paid net adds of 5.0m, representing -8% YOY with only 300,000 adds in the US and 4.7m for the international segment.
Alarm bells should be sounding in the halls when the most lucrative segment is estimated to decelerate by 8% YOY.
Domestic subscriptions deliver higher margins bumping up the average revenue per user (ARPU).
Contrast this with Netflix’s basic Indian package costing $7.27 or 500 rupees and a mobile package of $3.63 or 250 rupees.
In my opinion, domestically decelerating in the high single digits does not justify the additional annual cash burn of half a billion dollars even if you accumulate millions of more Indian adds at lower price points.
This leads me to surmise that the quality of growth is beginning to slip, and Netflix appears to be running into the same type of quagmire Facebook (FB) is facing.
These models are grappling with stagnating or slowing North American growth and an emerging market solution isn’t the panacea.
The Netflix Indian packages are actually considered expensive by local standards meaning that Netflix’s won’t be able to crowbar in price hikes like they did in America.
On the positive side, Netflix did beat Q1 estimates with paid net adds up 9.6 million with 1.74m in the US and 7.86m internationally, up 16% YOY.
Netflix was able to reach revenue of $4.5B, a company record mostly due to the $2 price hike during the quarter in America.
The letter to shareholders simplifies Netflix’s tactics to investors explaining, “For 20 years, we’ve had the same strategy: when we please our members, they watch more and we grow more.”
What this letter doesn’t tell you is that Disney and the looming battle with Netflix will reshape the online streaming landscape.
In simple economics, an increase of supply caps demand, and don’t get sidetracked by the smoke and mirrors, Disney and Netflix are absolutely fighting for the same eyeballs no matter how much Netflix plays this down.
To highlight an example of how these two are directly competing against each other – let’s take the cast of Monica, Chandler, Rachel, Ross, Joey, and Phoebe – in the hit series Friends.
Netflix acquired the broadcasting rights from Warner Bros, who owns Disney, and it was the most popular show on Netflix.
Warner Bros, knowing that Disney were on the verge of rolling out an online streaming product, renewed Netflix for 2019 at $80 million.
Not only were they hand feeding the enemy in broad daylight, but they handicapped their new products as it is about to debut.
Whoever made that decision must go into the hall of shame of boneheaded online content decisions.
Once 2020 rolls around, Disney will finally be able to slap Friends on Disney Plus where it belongs, and the streaming wars will heat up to a fever pitch.
Ultimately, when Netflix brushes off reality proclaiming that if they please viewers with the same strategy, then everything will be hunky-dory, then I would say they are being disingenuous.
The online streaming industry has started to become more complex by the minute and the “same strategy” that worked wonders in a vacuum before must evolve with the times.
At $360, I would short Netflix in the short to medium term until they prove the headwinds are a blip.
If it goes up to $400, it’s a screaming short because accelerating cash burn, poor guidance, decelerating domestic net adds, and a jolt of new competition aren’t the catalysts that will take shares above the heavenly lands of $400, let alone $450.
Netflix is still a fantastic company though – I’m an avid viewer.
Global Market Comments
April 16, 2019
Fiat Lux
Featured Trade:
(WHY YOU WILL LOSE YOU JOB IN THE NEXT FIVE YEARS,
AND WHAT TO DO ABOUT IT),
(BLK)
Global Market Comments
April 15, 2019
Fiat Lux
Featured Trade:
(MARKET OUTLOOK FOR THE WEEK AHEAD, OR QE IS BACK!),
(SPY), (TLT), (TSLA), (DIS), (FCX), (GOOG), (MSFT), (AMZN)
Let me warn you in advance that I am only going off drugs long enough to write this newsletter.
This year’s flu has finally laid me low and let me tell you it is a real killer. Perhaps it is my advanced age that has magnified its effects. Then I developed an allergic reaction to the flu medicine I was taking. For a couple of days there, I was looking like the Michelin Man.
However, I did have a lot of time to read research. And what I learned was sobering.
For a start, we are fully back to a quantitative easing market. In one fell swoop, the Fed went from an expectation of four interest rate hikes in 2019 to none. By ending quantitative tightening early, it has cut the amount of cash it is withdrawing from the financial system from $4.3 trillion to only $1.5 trillion.
The Fed is in effect reflating the bubble one more time. And what do you do in a QE-driven economy. YOU BUY EVERYTHING! This explains why stocks, bonds, commodities, and energy have all been marching upward in unison this year even though that is supposed to be theoretically impossible.
Yes, the decade long liquidity-driven bull market may have another leg up to go.
A higher high inevitably leads to a lower low. The trades you are executing now may be akin to picking up pennies in front of a steam roller. We are clearly planting the seeds of the next financial crisis. But for now, the pain trade is clearly to the upside.
Those of who who traded through the dotcom bubble are seeing déjà vu all over again. Huge money-losing tech companies are now floating IPOs on a daily basis. This too will end in tears, which is why I have recommended to followers to avoid all of them. This is a sucker’s game.
There is a cloud behind this silver lining. After a ballistic 21.43% move in the Dow Average in four months, markets are trading as if risk is a thing of the past. The euphoria is here and complacency rules. That means the number of new possible low risk/high return trades out there has fallen to zero.
There is another cloud to worry about. The more excess stimulus the Fed provides the economy now, the fewer resources it will have to get us out of the next recession, which might be only a year off. As a result, everyone is long but extremely nervous. They are still participating in the party but are standing next to the exit door. Pent up volatility is building like a volcano ready to explode.
The other great revelation is that markets have been trading extremely short term in nature, only one quarter ahead of what the real economy is doing. So, a stock market meltdown in Q4 2018 discounted a collapsing GDP growth in Q1 2019 of a 1% rate or less. That is down 80% from a year ago peak.
The ultra-strong market in Q1 is anticipating an economic rebound in Q2, After that, who knows?
That’s why I am moving both of my trading portfolios for Global Trading Dispatch and the Mad Hedge Technology Letter to 100% cash positions in the coming week.
Last week was the week when Walt Disney (DIS) morphed from being a has-been media stock hobbled by a failing holding in ESPN to a dynamic company that is suddenly taking over the world. The reward was an eye-popping 25% move in three weeks, which we caught.
Copper demand is rocketing, off of soaring global electric car production. Each vehicle needs 22 pounds of the red metal, and 4 million have been built so far. That number reached 5 million by June. Take a second bite of the apple with (FCX) as well.
General Electric got slaughtered again, with an earnings downgrade from Morgan Stanley. It will take years to sort out this mess. Avoid (GE).
The 30-year fixed rate mortgage plunged to 4.03% and may save the spring selling season for residential real estate.
Apple Topped $200. It looks like the market is finally buying the services story. Stand aside for the short term. It’s had a great run, up 42% from the December low. I’m waiting for 5G until I buy my next iPhone, probably next year.
The Mad Hedge Fund Trader hit a new all-time high briefly, up 15.46% year to date, and beating the pants off the Dow Average. Good thing I didn’t buy the bearish argument. There’s too much cash floating around the world. However, my downside hedges in Disney and Tesla cost me some money when I stopped out. I was late by a day.
We are taking profits on a six-month peak of 13 positions across the GTD and Tech Letter services and will wait for markets to tell us what to do next.
April is so far down -1.50%, as my downside hedges in Tesla (TSLA) and Disney (DIS) cost me some sofa change. My 2019 year to date return retreated to +13.92%, paring my trailing one-year return back up to +27.22%.
My nine and a half year return backed off to +314.06%. The average annualized return appreciated to +33.65%. I am now 100% in cash.
The Mad Hedge Technology Letter has gone ballistic, with an aggressive and unhedged 30% long which expires this week. It is maintaining positions in Microsoft (MSFT), Alphabet (GOOGL), and Amazon (AMZN), which are clearly going to new highs.
It’s going to be a dull week on the data front after last week’s fireworks.
On Monday, April 15 at 8:30 AM, we get the April Empire State Index. Citibank (C) and Goldman Sachs (GS) report.
On Tuesday, April 16, 9:15 AM EST, we learn March Industrial Production. Netflix (NFLX) and IBM (IBM) report.
On Wednesday, April 17 at 2:00 PM, we get the Fed Beige Book Indicators. Morgan Stanley reports (MS).
On Thursday, April 18 at 8:30 the Weekly Jobless Claims are produced. At 10:00 AM EST, we obtain the March Index of Leading Economic Indicators. American Express (AXP) reports.
On Friday, April 19 at 8:30 AM, the markets are closed for Good Friday.
As for me, I am staying planted in my bed reading up on research and watching HBO until I kick this flu. After that, I should be good for the rest of the year.
Good luck and good trading.
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader
Flat on my Back
Global Market Comments
March 21, 2019
Fiat Lux
Featured Trade:
(DIVING BACK INTO THE MOUSE HOUSE),
(DIS),
Walt Disney (DIS) shares have just suffered a 6% dive on the news they will buy the assets of 20th Century Fox in one of the largest entertainment takeovers in history. The new combined mega-company will dominate Hollywood and content production in general.
In fact, the new acquisition will enable the company to go from strength, enabling it to become the most powerful media company in well….the universe, to borrow from one of its many franchises.
This gives us a rare entry point to get into. Disney is just about to launch its own streaming service which will allow them to take a generous share of the Netflix and Amazon businesses.
Disney is spending a staggering $12 billion on new content this year. The parks are all packed to the gills. They already launch so many blockbuster movies that they have to be rationed awards at the Oscars.
It really is a company that is firing on all cylinders, as long as its erstwhile CEO Bob Iger doesn’t run for president in 2020.
I am therefore buying the Walt Disney Corp (DIS).
I’ll never forget the first time I met Walt Disney. There he was smiling at the entrance on opening day of the first Disneyland in Anaheim, Calif., in 1955 on Main Street, shaking the hand of every visitor as they came in. My dad sold the company truck trailers and managed to score free tickets for the family.
At 100 degrees on that eventful day, it was so hot that the asphalt streets melted. Most of the drinking rooms and bathrooms didn’t work. And ticket counterfeiters made sure that 100,000 jammed the relatively small park. But we loved it anyway. The bandleader handed me his baton and I was allowed to direct the musicians in the most ill-tempoed fashion possible.
After Disney took a vacation to my home away from home in Zermatt, Switzerland, he decided to build a roller-coaster based on bobsleds running down the Matterhorn on a 1:100 scale. In those days, each ride required its own ticket, and the Matterhorn needed an “E-ticket,” the most expensive. It was the first tubular steel roller coaster ever built.
Walt Disney shares have been on anything but a roller-coaster ride for the past four years. In fact, they have absolutely gone nowhere.
The main reason has been the drain on the company presented by the sports cable channel ESPN. Once the most valuable cable franchise, the company is now suffering on multiple fronts, including the acceleration of cord-cutting, the demise of traditional cable, the move to online streaming, and the demographic abandonment of traditional sports such as football.
However, ESPN’s contribution to Walt Disney earnings is now so small that it is no longer a factor.
In the meantime, a lot has gone right with Walt Disney. The parks are going gangbusters. With two teenage girls in tow, I have hit three in the past two years (Anaheim, Orlando, Paris).
The movie franchise is going from strength to strength. Pixar has Frozen 2 and Toy Story 4 in the pipeline. Look for Lucasfilm to bring out a new trilogy of Star Wars films, even though Solo: A Star Wars Story was a dud. Its online strategy is one of the best in the business. And it’s just a matter of time before they hit us with another princess. How many is it now? Nine?
It is about to expand its presence in media networks with the acquisition of 21st Century Fox (FOX) assets, already its largest source of earnings. It will join the ABC Television Group, the Disney Channel, and the aforementioned ESPN.
It has notified Netflix (NFLX) that it may no longer show Disney films, so it can offer them for sale on its own streaming service. Walt Disney is about to become one of a handful of giant media companies with a near monopoly.
What do you buy in an expensive market? Cheap stuff, especially quality laggards. Walt Disney totally fits the bill.
As for old Walt Disney himself, he died of lung cancer in 1966, just when he was in the planning stages for the Orlando Disney World. All that chain smoking finally got to him. He used to start out every TV show with a non-filter Luck Strike in his hand.
My own grandfather died the same way from the same brand, the one who fought in the trenches of WWI where Euro Disney sits today. It is a small world after all.
Despite that grandfatherly appearance on the Wonderful World of Color weekly TV show, friends tell me he was a complete bastard to work for.
Mad Hedge Technology Letter
March 18, 2019
Fiat Lux
Featured Trade:
(WHY ALPHABET IS THE BEST FANG TO BUY NOW),
(GOOGL), (NFLX), (FB), (TWTR), (DIS)
Why am I bullish on Alphabet (GOOGL) short-term?
Video has muscled its way to the peak of the digital content value chain.
If you don't have video streaming, then you are significantly depriving yourself of the necessary ammunition capable of battling against legitimate content originators.
The optimal type of content is short form yet engaging.
Interesting enough, the format method integrated into systems of Facebook (FB) and Twitter (TWTR) has experienced unrivaled success.
They have been leaning on this model as growth levers that will take them to the next stage of revenue acceleration and rightly so.
This has seen smartphone apps such as Instagram become game-changing revenue machines destroying all types of competition.
The x-factor that stands out in Instagram's, Facebook’s, YouTube’s model is that it's free and they do not absorb heavy expenses from content creation.
It’s certainly cheap when the user is the product.
Google’s YouTube service has morphed into something of a phenomenon.
Its interface is easy to use, and followers have a simple time navigating around its platform.
Familiar news outlets such as Sky News, Bloomberg News, and even CNBC news have recently installed their live feeds on YouTube's main platform scared of losing aggregate eyeballs.
And even more intriguing is that YouTube has become a legitimate competitor to Netflix's (NFLX) online video streaming platform.
YouTube has sensed the outsized pivot to their free platform and has double down hard by installing 5-second ads at the front end and middle of videos.
Of Alphabet’s total $39.3 billion revenue pocketed in Q4 2018, ads constituted 83% or an astounding $32.6 billion.
I feel that Alphabet shares are currently undervalued, and I believe that we will see outperformance from Alphabet shares for the rest of 2019 based on YouTube's performance relative to expectation.
YouTube’s ever-growing presence showing up in the top line will offer the growth investors desire to pile into these shares as the company wrestles with future projects such as Waymo.
That's not to say that their traditional advertisement business of Google Search is failing.
Investors can expect continuous 20% to 25% growth in this cash cow business, but the reason why Alphabet share has not been able to break out is that investors have baked this into the pie.
Therefore, YouTube is really the X Factor and will take them to this new promised land with shares surging past the $1,250 mark and more importantly, staying at that level.
YouTube brought in about $15 billion in 2018 and that consisted of about 10% of Alphabet’s total annual revenue.
However, the company is just scratching its surface of what it can accomplish with this fast-growing revenue driver and I can extrapolate this growth segment turning into 20% or 25% of the company’s annual revenue in the next few years.
Google does not strip out YouTube revenue in its reporting, therefore, it's difficult to put my finger on exactly how much YouTube is carving out in terms of revenue.
I can also assume that if Netflix continues to raise the cost of monthly subscription, this strategy will directly hurt its revenue acceleration ability as it relates to competing with Google's YouTube because YouTube's free service is demonstrably attractive to viewers hoping to discover high-quality content relative to a $20 per month Netflix subscription.
I do agree that Netflix is a great company and a great stock, but as they slowly raise the price of content, this will gift YouTube a huge chunk of Netflix’s marginal audience freeing itself from the shackles of Netflix’s price rises.
At some point, online video streaming will become as expensive as the cable bundles now, and at that point, we know that saturation is imminent boding negative for Netflix.
What I do envision in the short-term future are consumers in America will pay into several unique bundles such as Netflix, maybe Disney (DIS), ESPN and merely stick with these as their base content generators as more consumers cut their cord and hard pivot from traditional cable packages that are becoming less appealing by the day.
And don't forget that at some point, Netflix will have to demonstrate profitability and the huge cash burn that permeates throughout the business will be exposed when subscription growth starts to fade away.
In every possible variant, YouTube will become an outsized winner in the media wars because the quality of the free content keeps improving, the cost for consumers stays at 0, and their best of breed ad tech migrating from their Google search into YouTube just keeps getting more surgical and efficient.
Not only are the positive synergies from the best of breed ad tech aiding YouTube’s model, but just think about YouTube having access to the Google cloud and saving expenses by accessing this function to store data onto the Google Cloud.
If this was a standalone service, they would have to subcontract cloud storage functions to third-party cloud company causing the content service to spend millions and millions of dollars per year in expenses.
This would have the potential of crushing the bottom line.
That is just one example of the synergies that Google can take advantage of with YouTube under its umbrella of assets.
And think about self-driving vehicles, Google could potentially equip YouTube as a pre-programmed application inside of autonomous vehicle platform tech with YouTube popping up on the multiple screens.
I assume that there will be multiple screens inside of cars with self-phone driving technology because of the lack of driving required.
The worst maneuver that Alphabet could do right now is spinoff YouTube into its own company, and if that happens, YouTube won't be able to take advantage of the various synergies and benefits of being an Alphabet asset.
We are just scratching the surface of what YouTube can accomplish, and I believe this upcoming overperformance isn’t in the price of the stock yet.
If the Fed continues its “patient” strategy towards interest rates at a macro level, Alphabet will easily soar past $1,250 and it can easily gain another 10% in 2019.
If any “regulation” risk as a result of extremist content rears its ugly head, buy shares on the dips because the algorithms are in place to eradicate this material and any fine will be manageable.
Global Market Comments
October 12, 2018
Fiat Lux
Featured Trade:
(WHY THE STOCK MARKET IS BOTTOMING HERE),
(SPY), (INDU),
(NETFLIX SAYS WE BECOME A NATION OF COUCH POTATOES),
(NFLX), (M), (AMZN), (TSLA), (DIS), (GOOG)
