What Does Bill Ackman See in Netflix?
Last week, legendary investor Bill Ackman announced his purchase of more than 3.1 million shares of Netflix with a few simple words: “We are all-in on streaming.”
Over the course of a few days, Ackman’s Pershing Square Capital Management fund built a $1.2 billion position in the leading streamer. The man does not work in half measures.
Netflix needed the good news. It’s been a rough few months for the company. Netflix had already sagged 26% from its November high of $7001 before the bottom fell out on January 21. The culprit? Sluggish subscriber growth in Q4 2021. More worrying, though, was its pessimistic guidance for just 2.5 million new subscribers in the upcoming first quarter. $NFLX fell another 29% on that dour forecast.
In a sense, Ackman pouncing on a down-on-its-luck stock unduly punished by the broader market is a classic value play. Only Netflix isn’t exactly under-valued, even after its recent slump. $NFLX still trades at 40x earnings, which ranks well above other blue-chip tech growers like Apple, Meta Platforms (formerly Facebook), and Alphabet (formerly Google)2.
It’s not rocket science that companies can only support higher valuations if they’re still growing. Fast.
But the bigger the company, the harder it is to grow. And Netflix is already pretty darn big with 222 million global subscribers.
Netflix’s recent nosedive shows the danger of playing in this high-risk area of the market. Any sign of weakness, no matter how small, can cut that lofty P/E ratio down to size.
So what does Ackman see in Netflix?
Well, first off, he’s not buying that Netflix’s growth story is over. And the company’s top-line financials would seem to back that up. Over the past five years, Netflix’s revenue grew from $11.6 billion to $29.6 billion.
Net income looks even better. Over the same period, Netflix’s profits soared from $558 million to $5.1 billion. Needless to say, those are not the numbers of a struggling company.
In a sense, there’s your answer. If you think Netflix can keep this kind of growth up — and ramp subscriber growth back up — there’s not really anything to worry about.
Netflix’s slowing subscriber growth could also just be an odd artifact of the pandemic. Throughout 2020, when everyone was stuck inside looking for something to do, Netflix’s subscriber base exploded with 37 million new sign-ups. This number likely included subscribers “pulled forward” from future years who decided to join Netflix in 2020 because of quarantines and lockdowns. In other words, the 2020 results were impossible to live up to. That’s the bull case, anyway.
Ackman also highlighted Netflix’s “improving free cash flow profile”. This is a trickier knot to unravel.
After years of big FCF losses, it briefly turned positive in 2020 before sinking back negative this year3. One explanation for 2020’s high mark is that content costs (the price of creating, producing, and licensing new shows and movies) were much lower that year as studios shut down during the pandemic. Once large-scale production resumed in 2021, FCF turned negative once again.
Like everything with Netflix, it all comes down to content costs. Shows like The Crown, Stranger Things, and The Witcher (among many others) don’t come cheap. In fact, each of those three reportedly costs more than $10 million per episode to produce.
The $13-17 billion annual content outlay, which increases each year, remains a major drag on the company’s cash flow. If it’s driving growth, no big deal. If it’s just playing defense against Disney+ and other rival streamers, then we’ve got a problem.
These costs could be a perpetual issue for Netflix, since it needs to build up a huge library of content practically from scratch. Content that Netflix used to license from Comcast, Disney, Warner, ViacomCBS, etc. is being clawed back for those companies’ own streaming services. And, through no fault of their own, Netflix’s library of legacy content pales in comparison to the others.
Content costs aren’t going down any time soon and Netflix will likely always need to be at the head of that pack. It’s gonna get expensive.
On the bright side, Amazon once faced similar criticism about its own paltry free cash flow. It turned out that Jeff Bezos and co. were making massive capital investments in building out Amazon’s distribution network4, which gave the false impression of financial weakness. Instead, they were taking over the world. If so inclined, you could chalk up Netflix’s content costs as a similar growth expenditure.
Ackman ended his Netflix announcement with one of the best mission statements for value investing that I’ve ever seen:
Many of our best investments have emerged when other investors whose time horizons are short term, discard great companies at prices that look extraordinarily attractive when one has a long-term horizon.
Whether you feel $NFLX qualifies as a great company at an extraordinarily attractive price or not5, Ackman’s above advice deserves careful consideration. Let it guide your investment decisions and you’ll be well on your way to generational wealth.
Squid Game hype.
Re-naming companies is all the rage these days.
Netflix forecasts positive FCF in 2022.
Hi, two-day shipping.
In my case, Netflix goes in the Too Hard Pile.