10-15-2019

Short term play on Netflix – October/November.

I expect NFLX to guide down going into significant competition with large players with bigger ability to spend. While Netflix will grow more than those co’s internationally, there should be guidance below consensus for the US market, meaning that demand is fickle for NFLX. Further, accounting regularities may cause financial problems, including but not limited to – inability to access debt/equity markets and write dows on content assets.

159 ETFs hold NFLX in the US, including SPY, the most popular ETF in the world. Let’s look at some numbers.

• Market Cap $125 Billion

• Net Working capital of $-2 Billion, up from $-1 Billion last quarter. 

• Tangible debt: $23 Billion, Tangible assets: <$6 Billion

• Content Assets, Net: $23 Billion, up $8 Billion from 6 months ago. 

• Reported* Book value of $7 Billion, versus $5.2 Billion 6 months ago.

• Cash Flow $-1.2 Billion in 6 months vs. 2018 first 6 months of $-0.81 Billion

• Interest Expense: 50% increase YOY to $500 M. 

• $2.25 Billion debt raised last quarter.

Accounting for content assets is historically difficult for investors to discern for two reasons. 1) management has virtually all discretion on the value of the assets and 2) the costs of the content are spread out over as long as a decade, even though the costs are all upfront. At some point, investors have to ask, do subscribers actually care about the content or do they simply want to binge watch anything without commercials. If the latter is the case, new lower priced competition will destroy what value Netflix still has. The business model is broken at a time when the numbers have never looked worse, like cash flow dropping by $800 Million YOY.

As of

                                                                                                                                                                                                              September 30,                                                                                                                                                                                                               December 31,

                                                                                                                                                                                                                                2019                                                                                                                                                                                                                               2018

Assets

Current assets:

      Long-term debt 12,425,746                                                                                                                                                                                   

Total stockholders’ equity

Total liabilities and stockholders’ equity

*********** This cash flow statement shows most of the issue. “Additions to streaming content assets” and “Amortization of content assets” are not in sync. NFLX is spending more money every quarter, but amortizing about the same amount. As mentioned above, this is equivalent to buying inventory for $100, booking the inventory at $100, but only recording the cost of goods sold as $60. This is unprecedented.

The balance sheet above also spells danger, as net working capital is now -$2 Billion this quarter, a full 100% worse than last quarter only. Luckily, NFLX has the cash on hand to pay the interest expense on debt. Should this not be the case, NFLX will be insolvent.

Netflix was up after hours, despite missing earnings modestly on all fronts. Except EPS, which is a misnomer. During the quarter, NFLX added debt and lost cash, totaling a ~ $500M outflow. Despite that, Shareholder’s Equity rose $700,000,000 mostly due to the EPS number. NFLX spent almost $3.7 B on content, but charged $2.3 B, though that charge strengthened the balance sheet reported equity. $3.7 B in charges flowed to the assets side, while only $2.3 B was amortized out. The spend was 3.7 but only 2.3 was realized. The real EPS figure should have been close to – $500 instead of + $650 as reported. Eventually this will catch up when the rating agencies begin to notice a decline in stock price. The stock price has a high correlation with credit rating.