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Dilantha De Silva
Dilantha De Silva
Articles (99)  | Author's Website |

David Einhorn Might Lose More Money on Netflix

The guru's short position will come under pressure, as the company is proving to be resilient to the market crash

March 18, 2020 | About:

David Einhorn (Trades, Portfolio) is a famous critic of two high-growth companies: Netflix Inc. (NASDAQ:NFLX) and Tesla Inc. (TSLA). Greenlight Capital, the hedge fund chaired by the guru, is short on shares of both these companies. In the past, Einhorn has even engaged in verbal spats with Elon Musk regarding the true state of Tesla and its growth prospects and questionable accounting practices.

Despite the common belief that these two companies are grossly overvalued, both Netflix and Tesla are continuing to hurt the performance of the guru’s portfolio. On Feb. 29, Bloomberg reported that Greenlight Capital is down 3% for the month and more than 10% since the beginning of the year. The below chart, which plots the performance of the shares of these two companies and the S&P 500 Index, provides a hint as to why the guru is still making losses.

Source: Bloomberg

When global equity markets entered a freefall as a result of the spreading Covid-19 virus, many investors assumed that Einhorn’s short bets will bring back his glory days. However, as evident from the above chart, neither Tesla nor Netflix shares have fallen as drastically as one might expect. The latest data coming in regarding the demand for streaming services on a global scale gives reason to believe that Netflix in particular will continue to be resilient to this market crash.

In January, I wrote an article that discussed the fundamentals of the company and concluded that it might face short-term pressure but would most likely be a winner in the long term. The perspective on the near term, however, has materially changed as a result of the projected global lockdown.

A surge in streaming

None of the major over-the-top streaming companies, including Netflix, have commented about an expected spike in the usage of their services in the last few weeks. However, Bloomberg reported on March 17 that Wurl, a company that delivers video and advertising to connected TVs, has found the number of streaming hours on a global scale surging over the last weekend.

Source: Bloomberg/Wurl

Government authorities of many European countries have already restricted travel activities in their countries. Reduced travel and increased quarantine measures will prompt residents to look for indoor entertainment options such as video streaming. This is the most likely reason behind the recent spike in demand. Netflix, as a leader of this industry, is positioned well to benefit from this trend.

Market share of subscription video-on-demand services in Europe

Source: Statista

Upon studying app download data on Apple Store and Google Play Store, Bank of America analyst Nat Schindler wrote:

“Mobile app download data from Japan, Korea, and Italy, all validate this thesis (streaming is surging) and show improving year-over-year growth and sequential trends from February 21, the date where we saw the outbreak intensify in Korea and Italy. Potential strength in downloads relating to the stay-at-home impetus during the COVID-19 outbreak may yield modest 1Q upside to Street number.”

He ended the commentary by reiterating the "buy" rating for Netflix with a target price of $426, which indicates a 31% upside at the market price of around $325 on Wednesday.

Alternative theories

For investors, nothing is more important than leaving emotions and personal biases out of the investment decision making process. Often, a personal attachment with a brand name or a product has some impact on investments. This, however, can lead to an overestimation of the intrinsic value of a company.

Even though the demand for streaming has soared, this doesn’t necessarily mean that Netflix will gain new subscribers. For instance, existing subscribers might have spent an unusually high time using its services as a result of mobility restrictions. This, however, would not earn the company any incremental revenue.

Another theory is that the bulk of demand could have been directed toward competitors of Netflix. Even though the latter is an extremely unlikely scenario, this needs to be factored into the analysis as well.

Market leadership built on original content

Just over a decade ago, Netflix was known as the go-to solutions provider for DVD rentals. The growing internet penetration rates in the United States threatened the mere existence of the company before a dramatic change in fortunes occurred as Netflix introduced content streaming. Since then, the company has easily negotiated the threat from its competitors to stay on top of the industry on a worldwide basis.

The key to this success was the billions of dollars the company spent on creating original content. The below graph that plots the budget allocation of major players in the industry for 2019 provides a clear indication as to why Netflix is still on top of this billion-dollar market.

Source: Company filings

It might be surprising to learn that some of the most viewed TV shows on Netflix were created in foreign languages. Money Heist, which shot to global fame in 2018, is a Spanish series named Le Casa de Papel. This goes on to reveal the unprecedented market leadership of the company.

Reed Hastings, the CEO, confirmed in 2019 that billions of dollars will be invested in creating original movies and series in India, Latin America and the Middle East. The strategy is to produce high-quality content in local languages to grow the subscriber base. At the beginning of 2020, Netflix had a presence in 190 countries across the world, according to data from the Harvard Business Review. It would take years, if not decades, for its rivals to replicate this growth. The first-mover advantage is acting as a source of economic moat for the company, which could ensure the sustainability of long-term earnings.

Takeaway: Netflix seems resilient to the latest negative developments

If many countries follow the lead from China and Italy to impose a lockdown, the global streaming giant would likely see a surge in demand for its services. This, however, will be a short-term spike.

However, considering the deep library and the proven quality of Netflix’s content, it’s reasonable to assume that some of the new users will stay with the company for a long time. This is a positive development. While many entertainment companies, including movie theatre operators and theme parks, might find it difficult to grow their business in the next couple of quarters, Netflix has a high probability of doing the exact opposite as it benefits from consumers staying indoors.

Einhorn has always been correct about the cash flow troubles of the company and the expected increase in competition. However, what went wrong for his thesis is that Netflix always secured funding easily because of its massive growth and its market-leading position, which helped the company survive the onslaught from rivals. Both these factors will likely be features of the company in the next few years as well, which might lead to further losses for the guru in the short to medium term.

After carefully assessing the impact of Covid-19 on the global economy, it’s safe to conclude that Netflix will be one of the companies that would experience higher-than-expected growth in the remainder of this year. This makes the shares attractive from my perspective.

Disclosure: I do not own any shares mentioned in this article but might invest in Netflix shares within the next 48 hours.

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About the author:

Dilantha De Silva
I am an investment professional with 5-years of experience in financial markets. I specialize in U.S. equities and incorporate a top-down approach to identify developing macro-level trends and the companies that would benefit from such trends. I am a strong believer that the best investment opportunities could be found in under-covered equities.

I currently work with leading financial publications including Refinitiv, Seeking Alpha, ValueWalk, GuruFocus, and TradeGrill to produce investment-related content.

I'm a CFA level 2 candidate and an Associate Member of the Chartered Institute for Securities and Investment (CISI, UK). During my free time, I enjoy reading.

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