Netflix is hot, though admittedly the stock has been one of the most discussed names on the market for almost a decade now. This Monday's earnings report proved hot even for Netflix, as the stock jumped over 10% in after hours trading after the company announced it had beaten user growth by wide margins (5.2 million subscribers were added this quarter versus an expected 3.2 million). Fund manager Ben Weiss agreed to sit down with us to talk about why Netflix will continue to outperform the market. His fund 8th & Jackson Capital Management has held the stock since late 2016 when he posted a long idea on SumZero (which was already up 14% before Monday's boom).
Luke Schiefelbein, SumZero: Netflix is one of the most talked about stocks of the decade. What do you feel the market missing and why?
Ben Weiss, 8th & Jackson Capital Management: People underestimate Netflix’s international growth opportunity. Netflix is creating original movies and television shows in Mexico, Argentina, Italy, Brazil, Germany, Spain, India, Australia and Japan. No other entertainment company is investing as aggressively across the globe. As the international investments drive subscriber growth, the market will recognize that Netflix’s international business will be much larger than the U.S. business. The market also underestimates the depth of management talent, led by CEO Reed Hastings, and Chief Content Officer Ted Sarandos. It is like having LeBron James and Stephen Curry on the same team.
Schiefelbein: How does today’s earnings report fit in with your valuation?
Weiss: It was a strong earnings report driven by the quality and variety of the original content slate in Q2, as well as greatly beating expectations for user growth. As Netflix continues to produce more high-production value original content, the global appeal of the service will broaden. However, I take a long-term view because I believe that internet television is replacing linear television. Internet television provides a superior consumer experience because it is on-demand, accessible on any connected device, and costs less than cable. With over 100mm global subscribers, Netflix is building a dominant scale position in what will be a very large market. This should allow Netflix to compound business value for many years.
Schiefelbein: What will catalyze the market to realize the true value of Netflix?
Weiss: I doubt that there will be one catalyst. As Netflix continues to improve the quality and variety of its content, as well as the interface and technology of its app, consumer affection and adoption will intensify. If I had to choose one catalyst that could potentially shift sentiment even more heavily in Netflix’s direction, I would say it would be if one of the larger technology companies, such as Amazon or Apple, decided to bid on U.S. sports rights. That could seriously weaken the economics of the U.S. cable bundle, which would likely benefit Netflix’s competitive position.
Schiefelbein: Is Netflix still attractive to buy at today’s prices?
Weiss: It depends on your time frame. It is a volatile stock and sentiment is favorable at the moment. It is tough to predict where the stock will trade over the next several months. But if you have a long-term time horizon and plan to hold the stock for many years, I think you can do well, even at these prices.
Schiefelbein: What key metrics should investors be paying attention to as your thesis matures?
Weiss: Incremental operating margins. As Netflix reaches a more mature level, it should generate high incremental operating margins. Today, in the U.S streaming business, the incremental segment operating margins are over 50%. I believe these can go higher over time because content cost and marketing costs will become a smaller percentage of revenue as the business continues to scale.
Schiefelbein: What are the biggest risks associated with Netflix in your view?
Weiss: Near-term, the biggest risk is execution. Netflix operates a complex global business that demands flawless streaming, safe payment options, and great customer service. Some of those operational challenges become more difficult with size. Netflix also needs to continue making shows that people want to watch. Subscribers will value their subscription more if they find great content.
Longer-term, the biggest risk is shifting consumer preferences for different types of entertainment, brought on by changes in technology. It is difficult to predict the future of home entertainment. However, Netflix has a good built-in hedge against the unknown because it is building a deep library of owned content. To the extent that Netflix can create and own content that gives life to iconic characters and stories, it will own IP that will be durable for decades.
Schiefelbein: HBO seems to be winning the “content is king” battle, with hits like Game of Thrones, Silicon Valley, Girls, and backlog of evergreen classics (The Wire, The Sopranos, etc). Their HBO GO service seems comparable in terms of technological power, as do several other streaming sites (Amazon Prime, ShowTime, Hulu, etc). Why do you see Netflix dominating?
Weiss: It is not a zero-sum game. Streaming services will not be substitutes for each other if they have different content. If Netflix and HBO each produce great programming, they will both benefit because they will grow the overall market for internet television. Its not Coke versus Pepsi.