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Adam Levine-Weinberg  

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  • United Airlines' Path To Much Higher Profits [View article]
    A few things: First, just to use the example of CSX, it has a 25% pretax margin. Delta is working (successfully) to get to the 8%-10% range. You should not expect the two to have similar multiples, because there's clearly a lot more risk in the lower margin business.

    Second, United and Delta have both set an explicit goal of growing at less than the rate of GDP. So I would expect the long-term growth rate for large legacy carriers to be even lower than for rails or other industrials. I think you could make an argument that they are all overvalued, but it's hard for me to be excited about many airline stocks today. (That said, there are several higher growth/lower valuation names that I think are very attractive.)

    Third, rails have a huge moat that doesn't exist for airlines. The most important capital asset for a railroad is the track it owns, which represents an extremely high barrier to entry. By contrast, airline assets are inherently movable. Obviously, it's a bit of an oversimplification, but new airplanes can move into your market on a moment's notice.

    Arguing that rails and airlines are basically the same is effectively arguing that Warren Buffett is a moron, since he thinks airlines make terrible investments yet he plunged billions of dollars into BNSF. I think Buffett overstates the case against airlines, but I'm certainly not going to buy an airline stock over a rail stock without some kind of discount.

    Nov 22, 2013. 03:03 PM | 1 Like Like |Link to Comment
  • Danger Zone: Netflix [View article]
    Netflix had a pretax margin of 4.5% last quarter. But if you back out the international revenue and contribution loss, Netflix had a 13.4% pretax margin. That's not quite as high as the peak, but it's getting close, and has been rising pretty strongly in recent quarters. And non-paying customers represent less than 10% of the subscriber base.

    I think one of the big reasons why Netflix's stock price is so out of whack and so volatile is that the vast majority of arguments made for one side or the other are bogus. As an investor, it's pretty frustrating. But the market will sort things out eventually.
    Nov 22, 2013. 02:41 PM | 1 Like Like |Link to Comment
  • Danger Zone: Netflix [View article]
    Netflix has said that they are doing more marketing around DVD now in order to try to manage the decline. If I'm not mistaken, the "cost" of the free month is classified as a marketing expense. I would assume that this is what's going on.
    Nov 22, 2013. 02:31 PM | 2 Likes Like |Link to Comment
  • Danger Zone: Netflix [View article]
    David: First, I agree with the general thesis that Netflix is overvalued based on any reasonable growth assumptions. But it seems like your entire model is held up by the 15% pretax margin projection. I would say that most Netflix bulls think the company is becoming a "media" company with a potential for 30% margins or better. With more original and exclusive content, Netflix should have better pricing power in the future than it did two years ago. Furthermore, just by adding subscribers Netflix can leverage the content it has already purchased.

    Your fixed margin assumption (even if it's generous for the next year or two) is basically an assertion that operating leverage doesn't exist for Netflix's business. Presumably that's due to competition for viewers from other services and competition for content, which would continue driving prices up. Personally, I'm sympathetic to that argument. But right now, you have a rigorous DCF model attached to a "hand-wavy" argument that costs are going up but price increases will drive away customers. What do you think the content cost inflation rate will be? What do you think the effect would be over the next several years of raising the base price in the U.S. to $8.99 or $9.99? Those are the really key questions, in my opinion.

    Nov 22, 2013. 10:08 AM | 2 Likes Like |Link to Comment
  • United Airlines' Path To Much Higher Profits [View article]
    I think it's a little late to talk about the airlines having low valuations. I was promoting this line of thinking last year when Delta was a single digit stock. At $27, I think it's a good company but not one that I want to invest in.

    IMHO, investors are flocking to United because it seems cheap on a P/S basis compared to Delta. It's basically been riding the coattails of Delta and US Airways for a year now. People seem to assume that there's no fundamental reason why United should have lower margins than its competitors.

    The problem is that United has a MUCH worse cost structure than Delta or the new American. The biggest myth around this $2 billion plan is that these are "cost cuts". To be clear: they are cost cuts from a baseline under which costs would have risen by $2.5 billion or more in the next 4 years (holding fuel prices constant). When the program is complete, United will have higher unit costs than it does today (again, holding fuel prices constant).

    Now, it's great to hold cost growth below the rate of inflation, which is what this plan does. But Delta and American have similar plans which will result in similar or better relative cost performance over the next 4 years. Bottom line: in 2017, United will still have the highest cost structure in the industry. United already has the best revenue performance in the industry, so there's more risk than upside there on a relative basis.

    Unless you think that the airline industry as a whole is going to sustainably earn well above its cost of capital (i.e. there are very high barriers to entry/expansion), I think United is in big trouble.

    Nov 22, 2013. 08:52 AM | 1 Like Like |Link to Comment
  • Netflix: Asking Key Questions For 2014 [View article]
    Bohsie: The big companies like Comcast, Time Warner, AT&T, etc. get the best pricing because they bring lots of subs to the table. Netflix can only do that if it brings ALL of its subscribers to the table. If it offers segmented service and only a few million people took the full "cable" package, Netflix would be a low-tier pay-TV company and would probably have to pay higher rates.

    BTW, just to be clear, this is totally a hypothetical. I don't think there's even a 1% chance that Netflix will ever do this. First, Reed Hastings has been very explicit about staying focused on the core offering (and that's really almost an ideology for him). Second, it doesn't make sense for the TV networks.

    What value does Netflix really bring to the table? It's basically a name with some software and delivery infrastructure that could be replicated for at most, a few billion dollars, and probably less. So if you're running a TV network, what's the advantage of selling your content to Netflix rather than selling direct to consumer, either alone or in partnership with other networks? Netflix is not really creating any value in the scenario we're discussing, so I don't see any way that this could become a major source of profit.
    Nov 20, 2013. 10:00 PM | Likes Like |Link to Comment
  • Netflix: Asking Key Questions For 2014 [View article]
    I think you are way off in your estimate of overhead. It's impossible to give an exact number, because cable operators don't break down costs to that level of detail between the video, internet and voice services that they operate on the same lines. However, for Comcast, content spending recently has been close to 45% of video revenue, and the operating income before D&A was over 40% of revenue for the whole cable segment (of which half the revenue is residential video).

    That suggests that the overhead, aside from capital investment (which would be necessary anyway to maintain the internet and voice services) is less than 15% of revenue. The biggest cost savings that Netflix could theoretically provide is just accepting a lower margin.

    On the other hand, Netflix would have to pay a LOT more if it is actually segmenting customers. Perhaps it could theoretically get ESPN for the market rate of $5.50 or so per sub, but only if it's buying for 33 million subs. And also taking ESPN2, ABC, the Disney Channel, A&E, and ABC Family, for another $6-$8 per sub. If it's just offering full service as a separate tier, it would either not be able to get the content at all, or would have to pay a premium.

    The other cost you have to keep in mind is internet bandwidth. I have a 6 Mbps connection, which is plenty fast for my needs. But if I was all of a sudden trying to stream 2 or 3 full HD feeds, I would need to spend another $20-$30/month on internet.

    Nov 19, 2013. 01:05 PM | 1 Like Like |Link to Comment
  • Netflix: Asking Key Questions For 2014 [View article]
    Netflix relies on people having internet connections, most of which are from the same companies that provide pay-TV. The additional cost of operating a pay-TV system once you have the equipment in place and are operating a high-speed internet business is not that large.

    I think we're basically on the same page about what cable channels charge in retransmission fees (although ESPN is actually a little pricier based on the stats I've seen). But the cable and broadcast networks insist on bundling their channels, and for the most part, they insist on being included for every subscriber. When they don't, the cost is more like $8-$10 per sub (and then the cable company gets a markup on top of that): think HBO, Showtime, Starz, etc.

    Also, would this service include commercials? About half of the TV industry's revenue comes from commercials, so if you're cutting them out you should expect to pay about twice as much. A bunch of networks are up in arms about the "Hopper" which basically lets Dish customers skip commercials. I can't imagine them rushing into the arms of Netflix, which has taken a clear stand as anti-commercial.
    Nov 18, 2013. 08:01 PM | Likes Like |Link to Comment
  • Netflix: Asking Key Questions For 2014 [View article]
    What's stopping them is cost. Anything is available for the right price, but Netflix's business model cannot support current season TV. TV networks can make $1-$2/month off of every pay TV subscriber through retransmission fees (ad revenue is just gravy). That's a guaranteed revenue stream of over $1 billion a year. This money is basically a ransom from pay-TV companies, because they can't afford to lose a key channel like TNT, TBS, AMC, USA, or even the big 4 broadcast networks.

    If Netflix starts getting access to the top content from these networks, they would be giving up their leverage with cable companies. So Netflix would probably have to offer something like $500M-$1B annually to each network to get its shows the day after they air. That's just not going to happen.
    Nov 18, 2013. 04:50 PM | Likes Like |Link to Comment
  • Netflix: Asking Key Questions For 2014 [View article]
    The vast majority were streaming, as evidenced by the fact that after the split, over 90% of U.S. subscribers kept the streaming plan. In fact, the major reason why membership was growing so quickly was that Netflix had introduced the streaming only plan in 2010.

    I don't think the competition between Netflix and Prime Instant Video 2 years ago is anything close to what it is today. Prime had a tiny content library when it launched; now it is in the same ballpark as Netflix.

    At the end of the day, I guess you think the original content is enough of an attraction to keep most subscribers around, even with a price increase. It would help if NFLX provided any sort of data on viewership for these shows. I suspect that while each show has its hardcore fans, there is a large swath of Netflix members who are not that committed to the originals, or the service overall. That's where you stand to lose with a price increase.

    As long as Netflix is adding 5-6 million subs per year, I'd be surprised to see them increase prices. It's just not worth the risk. Only when organic growth disappears will Netflix look for a new lever to pull to boost revenue/profit.
    Nov 18, 2013. 04:33 PM | 1 Like Like |Link to Comment
  • Netflix: Asking Key Questions For 2014 [View article]
    I don't think you quite understood my point. It's not that the subscriber count will drop; it's that it will stop growing, leading to multiple contraction. In the year ending Q2 2011 (before the last price increase), Netflix added 9.6 million domestic subscribers (nearly 60% growth). Prior to the price increase, that growth rate was actually increasing.

    After the price hike, while the subscriber number only dropped for one quarter, the growth rate was much slower. It's taken 2 years to get the next 9.6 million streaming subscribers (growth of about 20% annualized). If the next price hike causes a similar slowdown in growth (to 10% or less), I think multiple contraction would more than offset the EPS increase.
    Nov 18, 2013. 02:08 PM | Likes Like |Link to Comment
  • Netflix: Asking Key Questions For 2014 [View article]

    I'm not sure P/S is a very helpful way to think about Netflix, because it's meaningless outside the context of the company's long-term margin profile. If you think Netflix will be earning 30% or 40% pretax margins someday, then an internet company P/S is reasonable. But if you think pretax margin is going to be more like 15%, then it can't really be grouped with those higher margin companies.

    I think the price increase sensitivity analysis is a good exercise, but I think you vastly underestimate the impact of raising prices. The last time Netflix reported churn, it was losing about 5% of its customers each month! I'm sure churn is much lower now: maybe 3%? (It would be great if NFLX would start disclosing this again.) If Netflix loses 3% of its membership base every month under normal conditions, would it really lose just 5% more in total after raising prices by $2/month, or 25%?

    I think a better way to think about it is that a price increase would increase churn, which would then gradually come back to normal over time. Suppose NFLX increases prices starting Jan. 1. In Q1 churn might be up by 200 bps to 5%, and then decline 50 bps each quarter, coming back to 3% by Q1 2015. With a starting member base of 33 million, you'd have 5 million additional cancellations over the course of the year. So at the end of the year, you've given up 15% of your subscriber base in order to charge the rest 25% more.

    Then you have to think about the 55-60 million broadband households in the U.S. that don't have Netflix. By definition, these people aren't willing to pay $8/month, so at $10/month they will be even harder to win over. The end result is that you get a quick bump in revenue and earnings, but higher churn and lower new subscriber acquisition... i.e. much slower growth.

    I think that's why Netflix's management has been so opposed to raising prices. A price increase on Jan. 1 could probably take Netflix from $2 of EPS this year to $6-7 next year. But subscriber growth would fall off so much that Netflix could be a $200 stock (or less) when all is said and done.

    Nov 18, 2013. 10:43 AM | 2 Likes Like |Link to Comment
  • US Airways Investors Hoping For Merger Bailout May Be Disappointed [View article]
    I don't know about timeframe, but I agree that a settlement is the most likely outcome, with AA/US giving up slots and gates at National and not much else.

    I wouldn't be all that surprised to see LCC stock rally if the merger is approved. However, I think the stock is already trading for at least fair value, if not more. $40 seems highly unlikely, not just in 2014, but for the next several years. That would put AAG's market cap at nearly $30 billion, well ahead of where Delta sits -- and AAG is starting from a worse position in terms of profitability and has more execution risk.

    Here are just a few of the challenges AAG will face, aside from the normal integration issues: 1) big increase in transcon competition from JetBlue's "Mint" product, 2) Big increase in Southwest's capacity in Dallas by 2015 (particularly in major markets like NYC, DC, LA, SF, Chicago, etc.) due to repeal of Wright Amendment, 3) fare wars at DCA depending on how many slots are divested, 4) over-reliance on 50 seat and smaller aircraft as Delta quickly upgauges to lower CASM aircraft; 5) Delta-Virgin joint venture makes London-NY more competitive.

    There will obviously be some revenue synergies from the bigger network and labor cost increases should be fully offset by other cost savings. But I still expect pretax earnings per share of the merged entity to be below what LCC is currently making, at least for the next few years.

    On top of that, American has a crazy fleet growth plan that creates fairly significant risks later this decade.

    Oct 27, 2013. 06:21 PM | Likes Like |Link to Comment
  • Short Netflix After Q3 Results: Fair Value $70 Per Share, 80% Downside Potential [View article]
    Great comment! It's too easy to just plug and chug with numbers that try to describe long-term growth. FCF could quite conceivably expand by several orders of magnitude in the next 5-10 years.

    However, while your subscriber target seems very achievable, I am skeptical that content costs will "only" grow to $6 billion by 2020. Just looking at the "cost of revenue" in the two streaming segments, it appears that Netflix is on pace to spend $2.5 billion-$2.6 billion globally on content. That's growing at 25%-30% annually! Even if the cost increases slow to a CAGR of 18%, content cost will hit $8 billion by 2020. That seems like a much more likely scenario.
    Oct 22, 2013. 07:25 AM | 7 Likes Like |Link to Comment
  • Apple Earnings And Guidance - Why I Think It Will Beat Analysts' Estimates [View article]
    This is an interesting analysis: definitely a great exercise to go through everything product by product. There are a few things that seem not quite right, though. I don't know where you are getting your iPhone ASP, but it seems way too low. If you divide Q4FY12 iPhone and related revenue by unit shipments, it works out to $637. (Even stripping out the related revenue, I can't get to the <$580 number you have in the ASP chart.)

    I wouldn't expect the ASP number to move very much. While there's been a gradual migration towards the lower-priced models, this is offset by the fact that Apple shipped a lot more new generation iPhones this year than last year. (I.e. opening weekend was 9 million this year vs. 5 million last year.) Since ASPs always jump when a new model is introduced, that should offset most or all of the secular decline.

    Lastly, I can't imagine that Mac revenue actually declined sequentially last quarter. Last year, Mac revenue jumped more than 30% sequentially due to back to school. Alternatively, if you look at the IDC data, Mac unit sales may have dropped 11% year over year in the U.S. If that's representative of the world, it would imply revenue close to $6 billion: more than $1 billion over your estimate.

    All in all, I think iPhone unit sales will be a little below your guess, with iPhone ASPs well above your guess and Mac revenue also higher. I think there's a good chance Apple will beat its guidance for revenue AND gross margin. But we'll see soon enough.
    Oct 18, 2013. 09:43 AM | Likes Like |Link to Comment