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Adam Levine-Weinberg  

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  • Netflix Is Ready To Buy On Underestimated Market Power [View article]
    I completely agree with the premise that Netflix's ultimate value turns on its ability to raise prices. However, the way that you are running the analysis skews the results in a few ways.

    1) You are building in a full year of subscriber growth despite the price increase. Strong sub growth and a simultaneous price increase will obviously lead to massive margin expansion.

    However, if you agree that the net result of a price increase will be stable subscriber numbers, then you should use the prior year's subscriber total when calculating revenue. In the hypothetical scenario that Netflix had raised prices at the beginning of this year, the proper sub base would be at most 33.4 million (the total number of free and paid subscribers at 12/31/13).

    2) You are calculating revenue using the end of year subscriber total. However, that's just the number of paying subscribers on Dec. 31 -- in a 15% growth scenario, there are significantly fewer paying subscribers earlier in the year. This is inflating your revenue estimate by a few hundred million dollars. I also think Netflix's costs are growing faster than your model allows, but it's hard to know for sure.

    3) Lastly, Netflix's costs won't stop growing just because subscriber growth starts to flatten out. Like Apple, Netflix is likely to see margins surge to a peak and then drop back to a more sustainable level -- at least domestically. (This may be offset by ongoing margin improvement outside the U.S.) Content costs are rising dramatically, and so I think Netflix needs to plan on increasing domestic content spend by at least 15% annually for the foreseeable future just to maintain the current quality of the content library, let alone improving it.

    Mar 26, 2014. 10:59 AM | Likes Like |Link to Comment
  • American Airlines: Expanding Network In China And Modifying Its Fleets [View article]
    I didn't say it was a mistake. I said it was necessary to expand the network and win corporate travelers over time. However, it's very normal for new airline routes to take a year or two to reach profitability, and I don't think this one will be any different.

    American's unit cost (CASM) was a little over $0.13 last year, excluding special items. For a long-haul transpacific flight like Hong Kong, the unit cost would be lower: maybe $0.11. (Obviously, that's just an estimate, but I think it's a reasonable one.) This summer, flights are selling for around $1600 roundtrip: that's a little under $0.10 in PRASM. Move forward to September and the fare is around $1200 roundtrip: down to 7.5 cents.

    Obviously there are some people who buy refundable tickets, and some who will buy a business class or first class ticket. And there is some cargo revenue, but that's a small fraction of the total revenue for any flight. (Airline capacity between the U.S. and Asia has been rising rapidly in the last few years, which has pushed down cargo yields significantly. Just look at United's cargo revenue results in the last couple of years.) On the flip side, no route has a 100% load factor.

    The bottom line is that I don't think American is defining success on these routes as having a 15% profit margin in the first year. If they can make some money in the summer and not lose too much more in the winter, while gaining some market share for U.S.-Asia travel, I think Doug Parker and company will be happy. I think your Wal-Mart toothpaste analogy might be closer to the truth than you suspect!
    Mar 14, 2014. 03:25 PM | 1 Like Like |Link to Comment
  • American Airlines: Expanding Network In China And Modifying Its Fleets [View article]
    This idea that any Asian/US market will make money is completely false. It is incredibly expensive to operate these flights (Dallas to Hong Kong is more than 8,000 miles; this flight will likely use over $100K of fuel each way). US-China freight capacity has exploded in recent years and cargo yields have dropped significantly. Cargo is still a source of ancillary revenue, but these flights have to make their money with high yields.

    I see the new Hong Kong and Shanghai flights as network driven -- to win corporate accounts, American needs to have more flights to China. In that sense, they should hopefully contribute to long-term profitability. In the near term, both flights are likely to lose money.
    Mar 12, 2014. 04:12 PM | Likes Like |Link to Comment
  • Best Buy: Target Price $35 For 2014 [View article]
    You're missing the point. Best Buy has a lot more risk than the market as a whole, yet it trades for essentially the same valuation. You're not getting compensated for the risk.

    In late 2012, when Best Buy was trading for $11 or $12, investors were getting richly rewarded for taking on risk. At that point I was recommending the stock.

    Now, even after the stock has corrected sharply lower, Best Buy still doesn't look especially enticing.
    Mar 4, 2014. 11:43 AM | Likes Like |Link to Comment
  • Here's How The Comcast And Netflix Deal Is Structured, With Data And Numbers [View article]
    OK, so the Netflix CEO confirmed that Netflix will be paying more to Comcast than it was paying when sending data over third-party networks. However, he also said that the change does not impact Netflix's guidance for 400 basis points in domestic contribution margin expansion this year. To me that would suggest it will cost millions but not tens of millions of dollars.
    Mar 4, 2014. 11:32 AM | 1 Like Like |Link to Comment
  • Despite The Stock's Rally, HP Should Be Split Up [View article]
    Ink costs as much as it does because printing has always been a razor/razor blades business model, although HP has changed their strategy in most developing countries. In the U.S. and other developed markets, printers still get sold below cost based on the idea of an expected lifetime value. Consumer printers are not worth very much to HP or other OEMs because many people will just buy generic ink, refill cartridges, etc.

    On the other hand, I do not think there is any evidence that printing is declining in the enterprise. Ink/toner volumes have been stable over the last several years even though printer sales were actually dropping a few years ago. Printer sales have now returned to growth. Why are people buying millions of printers if they aren't going to print?

    The PC business has a negative cash conversion cycle and a very high ROIC for HP. I'm sorry that I don't have an exact figure. My sense from HP's comments is that it may have a higher ROIC than the corporate average simply because there is so little capital invested in PCs.

    I take your point on operating leverage. We are comparing to different things. I think of automakers as companies with high operating leverage. A 20% gain or decline in auto sales is the difference between a 10% operating margin and a -5% operating margin. A 20% gain or decline in PC sales might be the difference between a 5% margin and a 2% margin.

    I am sure that the PC business is holding back HP's valuation. But rather than selling it for pennies on the dollar or spinning it off with huge cost dis-synergies, I would prefer that HP take advantage of its high cash flow and absurdly low stock valuation to buy back shares aggressively. Unfortunately, it seems like the "once bitten twice shy" logic is haunting HP. A few years ago, the company was spending ~$10B a year buying stock at $40 or more while the business was falling apart. Now the business if healing and the stock price is lower, but the buyback pace has been quite slow.

    Mar 3, 2014. 04:33 PM | 2 Likes Like |Link to Comment
  • Despite The Stock's Rally, HP Should Be Split Up [View article]
    There's a huge difference between printing and 3D printing. In any case, I'd be surprised if 3D printing goes as "mainstream" as investors seem to think will happen. It's great for some industrial applications and hobbyists, but I don't think there will ever be a time when 3D printers are common.
    Mar 2, 2014. 09:37 PM | 1 Like Like |Link to Comment
  • Despite The Stock's Rally, HP Should Be Split Up [View article]
    Samuel: Sales of printers were up last quarter, for the third straight quarter. A large portion of the printer value chain is in Japan, and the 25%-30% decline of the yen in the last year and a half has led to price deflation. Lower COGS and lower ASPs, but higher profits. If the exchange rate swung back to 77 yen/dollar, HP would probably be posting high single-digit revenue growth in printing, while operating margin would be plummeting. I'll take the revenue contraction and solid earnings growth every day of the week.

    If by "people" you mean consumers, the answer is of course people are printing less. If you're looking at enterprises, I think the answer is different. There are businesses that have swapped out paper for tablets in some instances, but printing is not declining very rapidly in the enterprise.

    There's not much operational leverage at all in HP's PC business. It's almost all contracted out so the costs are variable. The one area where operational leverage is significant is the enterprise services business, and that's where HP is cutting a lot of fat. If ES revenue stabilizes, the business will see significantly improved profitability in the next 1-2 years. If revenue keeps declining, then you are correct that profit will still be elusive in that business.

    It's very clear that splitting HP would entail at least $1 billion of cost dis-synergies from lost purchasing power. From what I'm seeing, the turnaround is progressing steadily, and I do not think that separate management teams would be able to produce operational improvements that could offset those cost dis-synergies. Hence, better together.

    Mar 2, 2014. 11:13 AM | 3 Likes Like |Link to Comment
  • Best Buy: Target Price $35 For 2014 [View article]
    JCP has $1.5 billion in the bank and burned nearly $3 billion last year. In a best case scenario, it will have $500 million in the bank going into the holiday season. More likely the company will need to sell off more assets to stay solvent through the holiday season.

    Anybody who's paid attention to what's gone on at JCP in the last 2-3 years would recognize that the fact that management said the company has enough cash is meaningless. The last two years have been full of announcement about how JCP is "turning the corner", executives are "encouraged", "no need to raise cash", and all of these statements were eventually exposed as false hopes.

    JCP's recent stock rally is analogous to Rite Aid's big rally in the last year and a half. When your market cap falls so low that your enterprise value is comprised almost entirely of debt, then small revisions to the probability that you'll go bankrupt can lead to huge swings in the stock price. It wouldn't surprise me whatsoever if JCP stock doubles this year. It also wouldn't surprise me if the company files Ch. 11.

    As for BBY, it seems to me that 10% is an unusually low cost of equity. Isn't 12% a more normal figure? I suspect that would chop at least $5 off your target price. I don't particularly object to your FCF estimates, but I wouldn't buy BBY at $26 based on FCF growing 3% annually from current levels. Not much upside considering the risk that the business could collapse due to competition, which I think is a very real risk.
    Mar 2, 2014. 11:03 AM | Likes Like |Link to Comment
  • Despite The Stock's Rally, HP Should Be Split Up [View article]
    Not to be too harsh, but the stock market disagrees with your assessment of HP. You can interpret that how you want. My personal take is that the stock market can be very wrong for a long time... and that this is the case for AMZN (and was the case for HPQ a couple of years ago when the stock was down in the teens).

    AMZN's FCF was a little over $2 billion last year -- a small fraction of HP's FCF. Plus, over half of Amazon's FCF was the result of stock-based compensation. If the employees were paid in cash based on the stock price and then the company issued new shares, it would have the same net effect without showing up in free cash flow.

    Anyway, I digress. There's really no evidence that HP's printing business is in decline. There is some price deflation, but HP's COGS is declining faster than its revenue. Pretax income for that business was up solidly last year.

    Obviously, people have different investing styles. You seem to go for growth at all costs. I don't think it's a problem that HP is not growing and not likely to grow much in the future. I'd prefer to have the company buy back 10% of its float every year and boost EPS that way rather than investing billions of dollars in long-shot R&D projects. When HP has tried to get in on the latest fad, that's where it has run into trouble.

    It's worth noting that about 70% of HP's revenue comes from PCs, printing, and low-margin outsourcing services. None of these businesses should need very much R&D spending. If you separate out those businesses and look at the software and enterprise hardware business units separately, R&D is much higher as a percentage of revenue than the company average.
    Mar 1, 2014. 09:21 PM | Likes Like |Link to Comment
  • Here's How The Comcast And Netflix Deal Is Structured, With Data And Numbers [View article]
    I wouldn't go quite that far. However, I would think it was a strategic mistake if Comcast gave Netflix better service at a lower price than what it was paying to third parties. My expectation is that Netflix would be paying perhaps $5-$10 million extra beyond what it would have paid to move the same video traffic over third-party networks. That seems like a reasonable price for Netflix to pay for significantly better service to about 1/4 of U.S. broadband subscribers. But that dollar range is just a guesstimate -- I don't have any inside sources!

    TWC's value depends to a large extent on how fast its video subscriber base erodes. Comcast would be better off letting the deal get blocked if the alternative is to empower a disruptive competitor (Netflix) so that TWC loses video subs even faster. Just my two cents.
    Mar 1, 2014. 01:28 PM | 2 Likes Like |Link to Comment
  • Here's How The Comcast And Netflix Deal Is Structured, With Data And Numbers [View article]
    Maybe, but that would require some serious short-term blinders. Spend billions of dollars to buy a cable company, then help your disruptive competitor lower its costs and improve its service quality in order to more quickly cannibalize the cable customers you just bought at a premium? Doesn't make much sense!
    Mar 1, 2014. 09:21 AM | 1 Like Like |Link to Comment
  • Here's How The Comcast And Netflix Deal Is Structured, With Data And Numbers [View article]

    I think you make a lot of good points here. But I want to push back on two specific things.

    First of all, peak Netflix traffic is probably higher than "Google, Microsoft, Yahoo, AOL, Amazon" combined. So why wouldn't Netflix be paying as much as those content providers combined, given that pricing is based on a per Mbps rate? I can't imagine that Comcast would give Netflix enough of a volume discount to more than offset the fact that it's delivering more content than all of the others put together. That would suggest that the $30-$60 million figure you threw out is also a good guesstimate of what Netflix is paying.

    Second, why is Netflix using Cogent or Level 3 at all if it can get guaranteed better service at a lower cost through a paid peering arrangement with ISPs? It doesn't make sense to me that Netflix wouldn't jump at the opportunity to pay 10% or 20% more to guarantee better service for its customers. And if that's the case, then why would Comcast offer this service at a price less than what Netflix would otherwise be paying to Cogent or other third parties?

    Feb 28, 2014. 04:50 PM | 2 Likes Like |Link to Comment
  • Netflix Pushes Closer To The Edge [View article]
    Well, I guess it's time to test the theory that analysts will downgrade Netflix on valuation. Netflix is now past $450 and about 20% above the mean and median price targets, so you would think that would imply underperform ratings from most of Wall Street.

    However, over the past year, analysts have been more inclined to raise their price targets to catch up with Netflix stock rather than downgrading. It will be interesting to see how this plays out. Rationality hasn't made frequent appearances in the last few years as Netflix went from $300 to $50 to $450.

    For example, I was pretty surprised to see Netflix add another $1.3 billion to its market cap this week on the news that it's paying Comcast for peering. IMO, this is probably more expensive than going through an intermediary like Cogent... why wouldn't Comcast charge for better service?
    Feb 25, 2014. 06:30 PM | Likes Like |Link to Comment
  • Is Netflix Really Worth Over $10 Billion More Than Time Warner Inc.'s HBO? [View article]
    I would love to see an analysis of the cable vs. internet-only business models for HBO. Unfortunately, I don't have the industry contacts to do a good job with it myself.

    It seems to me like HBO would have already dumped cable if the case for doing so was clear-cut. However, while HBO is sharing revenue, it also gets significant benefits. Most importantly, Netflix spends over $1 billion a year on non-content related stuff. Marketing is the big one, but there's also content delivery, and then the cost of building and maintaining a high-traffic web property.

    On top of that, cable operators often have 3 months or 6 months of free HBO as an enticement to get people to sign up. I would guess that HBO subsidizes that offer in some way, but HBO is still probably getting some amount of money from those subscriptions which is coming out of the cable company's marketing budget.

    Having a dedicated pipeline is also worth something. Plenty of people in the U.S. (myself included) don't have an internet connection that's suitable for full-HD streaming.

    I think these factors all make the benefits of the direct-to-consumer model less clear cut. That said, I agree that the market will probably move that way eventually. It just might take a while for HBO to get there.
    Feb 15, 2014. 02:05 PM | Likes Like |Link to Comment