Good article on NFLX

[watsa_is_a_randian_hero]

Harry - a few points

 

First, congratulations - you won over a 3 month period.  It looks like you exited your position as well, so you have a realized gain.

 

However, we will see what netflix does over the next 5 years.  My position is more based upon the competitive environment Netflix will encounter over the next few years, not subs they are adding today.  Prem was wrong on his CDS bets and down 75%+ over 4+ years before making 10x on his money.

 

Finally, position sizing is a valid form of risk control.  I started with a position that was a fraction of 1% of capital and averaged in as the price rose.  I have allowed the short to grow, and now have converted it to solely 2012 put spreads so that losses are limited.  You cannot argue position sizing is not a valid form of risk control.

[Guest HarryLong]

harrylong

 

hmmm, i don't see how proper risk control is the ultimate form of humility

 

you can have all the risk control in the word, but be arrogant, rude, put down others etc.

 

hy

 

Telling people that they are wrong is neither arrogant, nor rude. To the contrary, it treats people with the highest respect as rational beings who are capable of changing their ways. Only bigoted people see humans as superstitious entities incapable of logic. For a full explication of the bigoted view, one need only read How to Win Friends and Influence People which declares multiple times that people cling to their own wrong views despite all contrary evidence, quite like fanatics. In that view, people should be managed and handled, since they are incapable of being told in a forthright fashion that they are wrong. Science has somewhat confirmed this human defect under the heading of "confirmation bias."

 

I can agree with Parsad, that especially in this day and age, that telling people they are wrong can be construed at antagonistic.

 

After all, in large organizations, where most of us work, it rarely happens anymore.

 

I was re-reading The Organization Man recently, and it is fascinating. Keynes once said that "Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist." The same could be said of sociologists and industrial/organizational psychologists. For instance, in large organizations, the "social ethic", which should be more precisely called the "mediocrity ethic" exists.

 

Whyte points out on committee dynamics: "A really new idea affronts current agreement--it wouldn't be a new idea if it didn't--and the group, impelled as it is to agreement, is instinctively hostile to that which is divisive."

 

Whyte goes on in the book to point out that the "Organization Man" takes pains to be inoffensive, to reach for consensus, to suffer fools gladly, to reach agreement as opposed to truth, etc. Essentially, it is not a "social ethic" it is, in effect, an enforced ethic of mediocrity, which is driven more by the expediency to be promoted within an organization, than to find truth, novel solutions, new ways of serving the customer, developing new markets or products, etc. (Just imagine how far Steve Jobs would have gotten at GM or GE!).

 

So hyten1, when you think about it, your lack of comfort with people poking holes in wrong-headed ideas and thought patterns (and moreover, calling it rudeness or arrogance) is really a manifestation of the modern entrenchment of organizational dynamics, not only within society, but increasingly, within our minds. We are all happy to celebrate iconoclasts after society has recognized them, but not at the time a "new idea affronts current agreement." Perhaps risk control is this new idea in the value investing community that affronts some current consensus.

 

But the markets don't care about our feelings about being wrong, they care about truth. The market is brutal. It destroys the capital of people who don't care singularly about truth. That's why investment committees have real problems when it comes to performance. And yes, humility in markets starts, and ends, with risk control.

[Guest HarryLong]

Here is a link to the full online text.

 

 

http://books.google.com/books?id=tCK2OXs4P9UC&printsec=frontcover&dq=The+organization+man&hl=en&ei=OjLDTJ7RHsSqlAeDlqjWCg&sa=X&oi=book_result&ct=result&resnum=1&ved=0CC4Q6AEwAA#v=onepage&q&f=false

[Guest HarryLong]

Harry - a few points

 

First, congratulations - you won over a 3 month period.  It looks like you exited your position as well, so you have a realized gain.

 

However, we will see what netflix does over the next 5 years.  My position is more based upon the competitive environment Netflix will encounter over the next few years, not subs they are adding today.  Prem was wrong on his CDS bets and down 75%+ over 4+ years before making 10x on his money.

 

Finally, position sizing is a valid form of risk control.  I started with a position that was a fraction of 1% of capital and averaged in as the price rose.  I have allowed the short to grow, and now have converted it to solely 2012 put spreads so that losses are limited.  You cannot argue position sizing is not a valid form of risk control.

 

I will now move on to facts, which cannot be in dispute. First, it is intellectually disingenuous to assert that the this is all about "price movement". Again, confirmation bias is rearing its ugly head.

 

Let's look to the fundamental developments in that quarter:

---------------------

http://sec.gov/Archives/edgar/data/1065280/000119312510232617/dex991.htm

 

LOS GATOS, Calif., October 20, 2010 – Netflix, Inc. (Nasdaq: NFLX) today reported results for the third quarter ended September 30, 2010.

 

“Q3 represents our fourth consecutive quarter of more than one million net subscriber additions. This growth is clearly driven by the strength of our streaming offering. In fact, by every measure, we are now primarily a streaming company that also offers DVD-by-mail,” said Reed Hastings, Netflix co-founder and CEO. “At the same time, the introduction of our streaming offering in Canada in late September has provided us with very encouraging signs regarding the potential for the Netflix service internationally.”

 

Third-Quarter 2010 Financial Highlights

Subscribers. Netflix ended the third quarter of 2010 with approximately 16,933,000 total subscribers, representing 52 percent year-over-year growth from 11,109,000 total subscribers at the end of the third quarter of 2009 and 13 percent sequential growth from 15,001,000 subscribers at the end of the second quarter of 2010.

 

Net subscriber change in the quarter was an increase of 1,932,000 compared to an increase of 510,000 for the same period of 2009 and an increase of 1,034,000 for the second quarter of 2010.

Gross subscriber additions for the quarter totaled 4,101,000, representing 88 percent year-over-year growth from 2,180,000 gross subscriber additions in the third quarter of 2009 and 34 percent quarter-over-quarter increase from 3,059,000 gross subscriber additions in the second quarter of 2010.

Of the 16,933,000 total subscribers at quarter end, 94 percent, or 15,863,000, were paid subscribers. The other 6 percent, or 1,070,000, were free subscribers. Paid subscribers represented 98 percent of total subscribers at the end of the third quarter of 2009 and 97 percent at the end of the second quarter of 2010.

 

Revenue for the third quarter of 2010 was $553.2 million, representing 31 percent year-over-year growth from $423.1 million for the third quarter of 2009, and 6 percent sequential growth from $519.8 million for the second quarter of 2010.

 

Gross margin1 for the third quarter of 2010 was 37.7 percent compared to 34.9 percent for the third quarter of 2009 and 39.4 percent for the second quarter of 2010.

GAAP net income for the third quarter of 2010 was $38.0 million, or $0.70 per diluted share compared to GAAP net income of $30.1 million, or $0.52 per diluted share, for the third quarter of 2009 and GAAP net income of $43.5 million, or $0.80 per diluted share, for the second quarter of 2010. GAAP net income grew 26 percent on a year-over-year basis and GAAP EPS grew 35 percent on a year-over-year basis.

-------------------

 

Remember my big picture main point from earlier in the thread? Subscribers could increase, and the company could do it with a rational cost structure. Gross margin increases from 34.9 to 37.7 . A major part of the short thesis is not coming true--that competitors will drive down margins, content providers will gain more bargaining power and drive down margins, etc.

 

Graham said that all analysis should be penetrating, not prophetic. Penetrating analysis shows that the thesis is not coming true. If and when it starts to happen (margin deterioration, growth stops, etc), then it will be time to go short.

 

And I love this habit that I will call, in honor of Michael Lewis, "promiscuous historical analogy." ie, "Prem lost a lot on a trade before making 10X his money, so the same will happen to me."

 

Or better yet, the classic, "Buffett made a lot of money off the irrationality of others and Graham says to take advantage of the irrationality of others, so if I lose money on an investment, others are automatically irrational."

 

If you can prove that others are irrational, I suppose that is a defensible intellectual position, but it is not a defensible position when the very reasons one cited for getting into an investment or trade are being proven incorrect, or at least have not happened at all in any way shape or form, or in fact, the opposite has happened (margins expanded!).

 

 

[Guest Bronco]

Netflix is currently a great service....2 headed monster.  It is cheap enough, and you get movies mailed to you.  The iPad app is terrific.  As of today, they have a disruptive technology and more so, business.

 

That being said, I don't believe netflix has a long term moat.  I don't think apple will compete with them, but they could.  Somebody will try.  So it is not a long term investment "for me". 

 

But I don't like it as a short idea.  You can be right on the long term thesis but get killed waiting.  I would wait for a real competitor or something that will impact their profitability.

 

If radian, Harry and myself can all get along and we all want to make some serious money, we will find a way to develop a netflix type app for porn.  Market potential is giant.  (hope you both smile on this and enjoy a weekend filled with great potential sporting events, including my near elimination phillies.)

[twacowfca]

Harry, Netflix has always been in my "too hard" pile.  How were you able to determine that they would be able to transition to streaming video and maintain a dominant position?

[Guest HarryLong]

Harry, Netflix has always been in my "too hard" pile.  How were you able to determine that they would be able to transition to streaming video and maintain a dominant position?

 

Statistical analysis. By the way, twacowcfa, send me an email: info@contrarianindustries.com

 

I've been trying to get in touch with you.

[Josh4580]

Of the 16,933,000 total subscribers at quarter end, 94 percent, or 15,863,000, were paid subscribers. The other 6 percent, or 1,070,000, were free subscribers. Paid subscribers represented 98 percent of total subscribers at the end of the third quarter of 2009 and 97 percent at the end of the second quarter of 2010.

 

That looks like a huge increase to me in free subs.  The stock jumped on the number of subs added as they missed EPS and guidance numbers.  Not a good sign unless they are able to convert these free subs at a decent rate.

[Guest Bronco]

Josh, it may be a moot point.  A better question will be home many new iPad purchasers over the next 2 years (50 million?) will get netflix?

[twacowfca]

Of the 16,933,000 total subscribers at quarter end, 94 percent, or 15,863,000, were paid subscribers. The other 6 percent, or 1,070,000, were free subscribers. Paid subscribers represented 98 percent of total subscribers at the end of the third quarter of 2009 and 97 percent at the end of the second quarter of 2010.

 

That looks like a huge increase to me in free subs.  The stock jumped on the number of subs added as they missed EPS and guidance numbers.  Not a good sign unless they are able to convert these free subs at a decent rate.

 

The quality of free trial subs should be measured by their conversion rate to paid subscribers, not merely by their absolute numbers.  An increase in free trial subs with no substantial price reduction or degradation in the conversion rate would be a very good thing, in general.  Which is it?

[Guest HarryLong]

Mark Cuban on Netflix vs. Google TV

 

http://seekingalpha.com/article/231937-how-google-tv-could-hand-netflix-the-entire-streaming-universe?source=yahoo

[Myth465]

Tilson on his Netflix and Open table shorts.

 

http://www.cnbc.com/id/15840232/?video=1628416100&play=1

 

He touches on Risk Control.

[Guest HarryLong]

http://finance.yahoo.com/news/Netflix-raises-prices-for-apf-807371282.html?x=0&.v=2

 

The best risk control is being right.

[Guest Bronco]

Just changed my plan. 

 

Streaming on an Ipad is terrific. 

 

Will buy Apple TV product soon to take advantage of this. 

 

What happened to the music industry is happening to movies.  Distribution is now essentially free.  Teriffic.

 

I believe that is why the price is up today.  Mailing DVD's - yesterday's news.  Too expensive and slow.

 

 

I am playing this through Apple personally.  A good stock to trade, with biggest risk being Steve Jobs health. Good piece on Jobs on Bloomberg Game Changers for those interested.

 

Harry - good to see your presence on the board (although I might be one of the few that feel this way!).  Of course I am kidding - but more posts welcomed.

 

Good holiday to all.

[DCG]

Distribution isn't really free...that's basically what they're paying companies like Level 3 and Limelight for.

[Guest Bronco]

Looking at level 3's P&L and the amount of losses they incur, I would argue that they do work for free.

[brker_guy]

Looking at level 3's P&L and the amount of losses they incur, I would argue that they do work for free.

 

Really?  How so, Bronco?  Can you give us exact details on how Level 3 would work for NFLX for free?

 

In details, please!  What metrics did you use to come to that conclusion?

[ragnarisapirate]

I am curious, to add to what bronco said, if there will eventually be a pandora or last.fm for movies (basically, a souped up hulu or youtube) which gives away movies for free, as long as you put up with an advertisement. Additionally, Amazon is getting into online rentals, which are essentially blocks of time that you can stream movies on...

 

I just don't see there being a super moat for Netflix. I recently switched to Netflix from blockbuster's service, because it is presently better, but, If you gave someone a billion dollars, could they put a dent in Netflix? There is a possibility. For comparison's sake, Many people have chemical additions that make them gamble, buy booze, cigarettes, Coca-Cola, and McDonalds. While entertainment is very important to people, I know of nothing that can force you to buy movies from netflix. Conversely, screaming kids force you to take them to McDonald's.

 

All said, they will probably be able to grow significantly over time.

 

I dunno guys, I am pretty sure that I see arguments on both sides here, I sure as hell wouldn't want to be long or short Netflix.

[Myth465]

Looking at level 3's P&L and the amount of losses they incur, I would argue that they do work for free.

 

LOL Bronco. You consistently have me laughing out loud.

[Guest Bronco]

Ragnar - I am with you, not long or short.  But the product is good.

 

To be honest, I am not sure if Netflix breaks out costs of DVD rentals versus costs of streaming.  I will let someone smarter than me do that (which leaves the rest of the board to analyze). 

 

Are the costs 2:1 (DVD:streaming)?  5:1?  Interesting analysis. 

 

All the company has to say is that "we are a streaming (cloud) company" and add a billion to the market cap.  If they just said they are a pure play on cloud, the market cap would jump 2 billion.

 

Reminds me of a startup in the late 90's that sold dogcrap.  They really didn't make any money, or had any sales.  But they started a website and changed the business name to dogcrap.com.  They went public, made millions on the IPO, and later sold the entire company to yahoo. 

 

Anyone have some seed money so we can start a business - "Cloud Inc." or "Computing in the cloud, inc." or something similar.  Fortunes await.

[gfp]

I just received an email from netflix two minutes ago stating that they are raising the prices.  For my plan, 3 blu-ray discs at a time + unlimited streaming, the price is going from 20.99 / month to 23.99 / month.  This is their response to the content negotiations.  We'll see what the effect on membership churn is..

 

(the email also details a new 7.99 / month plan that only includes online streaming, no dvds)

 

all prices are usd

[ragnarisapirate]

 

Anyone have some seed money so we can start a business - "Cloud Inc." or "Computing in the cloud, inc." or something similar.  Fortunes await.

 

Bronco, In the event that you are serious, I have some cash I'll throw down (especially if we can lever the hell out of the company and raise cash with some toxic debt or something ;P). In the event that you are not (which, I am 99% sure is the case) I want to thank you for the humor that you bring to the board.

[Guest HarryLong]

Out of curiosity, after seeing the heated philosophical debate on this thread and observing the happenings in NFLX and CRM, I am curious if people on this board have moved closer to an acceptance of risk control, stops, etc, or (if they were previously not fond of risk control) their opinions are currently unchanged.

 

I suppose this question is a much about confirmation bias as the issue itself.

[Guest HarryLong]

Out of curiosity, after seeing the heated philosophical debate on this thread and observing the happening in NFLX and CRM, I am curious if people on this board have moved closer to an acceptance of risk control, stops, etc, or (if they were previously not fond of risk control) their opinions are currently unchanged.

 

I suppose this question is a much about confirmation bias as the issue itself.

 

Pretty quiet, eh? Where has all the passion gone about holding money-losing positions? It's not as fun in real life as it looks in the history books.

[Eric50]

Now is the time to short Netflix. It's way way overvalued. And the quietness on this thread confirms that...