You never know who is going to read what you write, so think before you speak. And don't say it or print it unless you're okay with it being broadcast all over the world. Those two pieces of advice apply to just about everything, including writing about stocks.
That said, before I submit an article for publication, I ask myself some basic questions. If I am referring to a person, how would I feel if they wrote what I wrote about them about me? If it's harsh, is it at least justified? And when I make a claim, do I feel like I can support it through some credible means?
Lately I have been quite hard on Netflix (NFLX). No, Reed Hastings did not call me out. But I did receive an email from Michael Pachter of Wedbush Securities. Michael read my latest Seeking Alpha article about Netflix and provided some feedback, particularly on my take on Netflix's conference call format. Instead of acting like I never received them, I think it's important to air Michael's views to give not only thoughts that oppose mine, but ones that, admittedly, are probably a bit better informed due to greater exposure.
On Netflix's conference call format, Pachter disagrees with my skepticism, noting it is "really efficient" and that the company answers "every question" from the sell side, but probably skips several from the buy side. Pachter told me "you can criticize them [Netflix] for a lot of things, but the conference call format shouldn't be one of them." Apparently, Hastings called Pachter after one recent call because he thought one of the answers he gave him was "confusing or non-responsive." That certainly says something (positive) about Hastings.
I take what Pachter says seriously. He covers the stock. He has interfaced with the CEO and, presumably, several other Netlifx executives. That said, while I respect and consider his opinion, I still wonder how much of the conference call format curtain Netflix really pulls back. It's only possible for Pachter to know if the company answers every one of his questions. Additionally, while efficiency sounds like a great reason for the format, control must absolutely be part of the picture. I reviewed the most recent transcript again and difficult discussions regarding expenses are simply absent from the conversation. Either the analysts aren't asking them or Netflix is ignoring them. Neither scenario would surprise me.
What's interesting to note is that this defense of Netflix's conference call format comes from an analyst with a sell rating and an $80 price target on the stock. Pachter thinks Netflix will continue to grow, but not enough to justify the "rich multiple" investors have placed on the stock. Pachter's biggest concern involves the money Netflix pays out to acquire content.
In an email he sent me Thursday morning, Pachter writes:
Although Netflix won’t admit it, most content owners look at it on a “per subscriber” basis. Starz certainly does, and Starz gets something like $2/month/subscriber from cable. If Starz goes to a 90 day delay for Netflix and goes to $1/subscriber/month, Netflix will have to commit to $240 million annually, with higher payments if they grow their subscriber base (keep it in the U.S., though).
The same thing will happen with ABC, CBS, NBC and Fox. They all charge cable per subscriber, and unless they delay a LONG time, it’s hard to justify giving Netflix a huge break. The bottom line is that content is going to cost Netflix around 35 – 50% of what it costs cable for a delayed feed, and that is likely going to suck up a greater share of their revenues than the Netflix bulls are willing to admit.
I can’t predict how many deals Netflix is going to sign, nor can I predict what they will pay. I can only predict that they will pay a lot more in the future, and based upon the prices of recent deals, I estimate that their costs will grow to $2 billion in 2012. They’ll save $200 – 300 million on postage and DVD purchases, but I estimate that their overall costs are going to go up by around $1.5 billion between 2010 and 2012. If revenues grow by more than that (I think that they will), Netflix will make more money, but I don’t think that the increase in earnings power will be as great as a $245 share price implies.
One thing is for sure: the more Netflix makes, the more the studios and TV networks will ask for in the next round, and the ABC and CBS deals show that the average term is dropping to one year. Another thingis likely: if Netflix makes as much as a $245 share price implies, they will attract competitors. The studios will then likely be able to benchmark value, and if Hulu or Amazon pay $1 per subscriber for content, Netflix will probably see its cost go from $0.50 (hypothetical) to $1. One of my competitors said competition will drive costs down; I completely disagree, and think competition will drive costs up, since more bidders for scarce content are likely to outbid one another. For an example of this, witness what happened to sports salaries when free agency was allowed.
Or consider what happened (and still happens in some neighborhoods) during the housing boom. Buyers purposely set low asking prices on homes in places like Manhattan or San Francisco's tonier districts to create bidding wars. Expect similar dynamics as the content providers gain even more of an upper hand on companies like Netflix. Pachter's cable analogy fits best, however.
Content providers are in no mood to give their programming away. If anything, they're a bit grumpy these days, given the bold moves taken by forward-looking cable companies like Time Warner Cable (TWC) and Cablevision (CVC). As content gets spread around to a growing number of devices and viewing methods, programmers see a clear path to more diverse revenue streams. And, if Pachter is right (I believe he is), that content costs will increase alongside subscriber growth, can Netflix find a way keep earnings growth up to speed with its inflated stock price?
Plus, Netflix will have to make it worth a content provider's while to sell to somebody else what they could stream at their own website. Simply put, Netflix and other independent streamers will need to put up enough cash to alleviate programmers' concerns that they could make more through their own ad- and subscriber-supported distribution networks. Disney (DIS) and Home Box Office, for instance, both see value in offering their programming, live and/or on-demand, via very different means than Netflix- or YouTube-style distribution. And, as more programmers work live streaming deals and the HBOGO initiatives continue to pop up, the allure of reruns and old movies becomes less appealing to consumers.
Pachter did not mention the increased international operating expenses that Netflix will face going forward. I assume he includes these costs in his estimates. Up and running in just one international market, Netflix estimates about a $50 million operating loss in the second half of the year alone. Building the brand, acquiring international rights to content as well as securing locally-appropriate programs, and spending what it needs to from logistical and infrastructure standpoints adds up to potentially massive costs that we've received little, if any, color on.
I appreciate Pachter's insight. With accountability all the rage these days -- and rightfully so -- I think it's important to present relevant feedback to what I write when people "in the know" offer it up.
Disclosure: I am short NFLX.
Additional disclosure: Author is short NFLX via a long position in put options.