It’s insane how important and relevant college football is and how it will influence the presidential election. Here is a recent ad by Biden, basically blaming Trump for the shutdown of college football, and of course conversely, this week Trump spoke directly with the commissioner of the Big10 in an effort to try to get them to play football. Politics!?

There are 5 so called “power conferences” in football: SEC, ACC, Big12, Big10 and Pac12. These conferences include the biggest schools in the US and make up the majority of college football viewing.  

So get this: the SEC, ACC and Big12 are hell-bent on playing football this fall. The Big 10 and Pac12 cancelled their seasons due to Covid – but those decisions may very well be reversed…more on that later.  

Think of the Pac12 as west coast schools and the Big10 as mid-west or upper middle US. Below is a great map/graphic to help visualize where these schools are.  

The SEC, ACC and Big12 include schools and regions that live and breathe football. Think Alabama, Texas, Florida, Oklahoma, etc… Football is a lifestyle, a religion, a way of life and it shows in National championships. 

National Football Champions for the last 15 years: LSU, Clemson, Alabama, Clemson, Alabama, Ohio State, Florida State, Alabama, Alabama, Auburn, Alabama, Florida, LSU, Florida, Texas.  

No Pac12 schools on that list and Ohio State from the Big10 is on the list once. 

How important is football? Well according to this thoughtful write-up the top 25 football programs combine to earn an annual profit of $1.5 Billion dollars on $2.7 Billion of revenue. Texas A&M is #1 bringing in almost $150 million in revenue and $100 million in profit. It’s widely understood that these football programs help fund all other sports. And don’t be mistaken; college football is a business and it’s very much about money and prestige.  

So now there is a lot of hoopla about the Big10 not playing. Apparently a vote was held a few weeks back among the presidents and chancellors of those schools and it was 11 to 3 against playing (there are 14 schools in Big10). Three schools voted to play: Nebraska, Ohio State and Iowa. 

The decision to not play has been embroiled in controversy. In fact, the Big10 just this week made public the results of the votes after significant public pressure, including lawsuits. Public institutions not being transparent around how they decided to cancel football is entirely inappropriate.  

BTW, nobody seems to care that the Pac12 is not playing. It’s three-fold: (1) The Pac12 is rarely in contention for a national championship, (2) the west coast does not bleed football like Texas and (3) the west coast is led by democrats that have locked down the states. Governor Gavin Newsom still has some of the most draconian authoritarian measures in place, so it’s hard to even imagine 4 of the Pac12 schools (USC, UCLA, Stanford, Cal) playing at all. 

My personal belief is these schools should be playing football. I think the athletes would be safer and healthier hanging out with each other, practicing, working out and getting tested regularly. They could even have them all live together. If these student-athletes are not playing football, they will be out socializing and partying regardless. 

Politics

No need to talk about the Pac12 much, because three of the states there: Washington, Oregon, California are blue democratic strongholds, housing 8 of the Pac12 schools. And nobody is really complaining about not playing. The Pac12 was arguably irrelevant, and they are boldly solidifying that position.

But the Big10 is VERY interesting for a few reasons: 

• Football is a bigger deal there. Everyone can name friends/acquaintances or famous people that went to either Michigan or Ohio state. Both those stadiums hold over 100,000 fans.  
• There is a lot of drama and controversy swirling. Fans are irate that they’re not playing. Nebraska football players and parents are suing the Big10 and have demanded all documents around decision making be made public.  
• Swing States. Battle Ground States. That’s right, there are a lot of them in the Big10. These are states where the presidency is decided.  

So let’s talk about the Big10 Battleground states: Michigan, Wisconsin, Minnesota and Pennsylvania.  4 states representing 56 electoral votes (Trump won 288 votes to Clinton’s 215).  Trump won Michigan, Wisconsin and Pennsylvania, but Obama won those states in 2012. Trump won Michigan by a margin of just 0.23%, Wisconsin just 0.77%, and Pennsylvania by 0.71%. Clinton took Minnesota by 1.5%. 

So in terms of Big Football programs in these states think: 

• Michigan – Wolverines. 46,000 students
• Michigan State – Spartans. 50,000 students
• Wisconsin – Badgers. 44,000 students
• Penn State – Nittany Lions. 47,000 students
• Minnesota – Golden Gophers. 51,000 students

These are BIG Schools, with BIG followings in BIG swing states. Trump won Michigan by just 10,000 votes. That’s like 1/10th of Michigan fans in the stadium! 

So if Michigan is not playing and the fans are pissed, the presidential election could come down to “who is to blame”. Do you think it’s Trump’s fault because he mismanaged Covid? That argument could work, but it is materially weakened if SEC, ACC and Big12 start playing football. 

Or do you blame the democratic leadership? Gretchen Whitmer is another lock-down heavy democratic governor who said “I was glad that the Big Ten took the leadership role that they did”. So maybe people blame her as a democrat and therefore Biden. 

One thing is for sure Trump wants them to play and he wants credit for them playing. I don’t think it’s playing well for the democrats at this point. The Big10 is now revisiting their decision and are talking about a revote.

In the meantime a lot of college football games will kick off this weekend and next. Imagine how the players in the Big10 and Pac12 are going to feel watching. Ouch. 

More fun to come in the near weeks ahead. 

Below are the electoral results (source: Wikipedia). 

Stock Market up 5% for the year

Stock Market up 52% from the low this year

An investment made on the first of every month since March 1, would be up 15%

I hope you haven’t been sitting on the sidelines this year! 

Many don’t/won’t realize, but almost exactly 6 months ago US Stocks reached a record high and now almost to the day 6 months later they are reaching new all time highs! All this in the wake of the fastest drop in history: down 34% in 32 days. And fastest recovery: back up 52% 5 months later.

The previous S&P 500 record of 3386 was reached on February 19, 2020, before it started its precipitous fall down 34% on March 23. This week on Tuesday August 18, 2020 (so 6 months to the day) the US Stock Market has again reached an all time high of 3390.

In fact stocks are now up almost 5% this year. That buy itself is a return ANY investor would welcome. 

ALL THIS DURING:

• Covid 19 pandemic shutdowns
• Depression era unemployment rates
• Nationwide protests, and
• (and if you live in California) Record forest fires and rolling blackouts. 

Who woulda thought? 

Moral of the story: 

Don’t try to time the market. You can’t. Nobody can. 

Just buy it and stick with it. So if you could have timed the market bottom and invested on March 23, your investment would be up 52%. But this is dumb, because nobody can. 

So instead, let’s say you simply just kept on investing at a constant rate (also known as dollar cost averaging). Six equal investments made on March 1, April 1, May 1, June 1, July 1 and August 1, would be up a combined 15%.  Again a return hedge fund managers would be quite comfortable with.

Some More Insanity

Apple is the first company to reach a $2 trillion valuation! 

Tesla is a $370 billion company. Giving them a similar market value of Ford, GM, Chrysler, BMW, Mercedes and Toyota all combined (~$376 billion). 

Netflix forecast 7 million new subscribers in the quarter and came in at 16 million. By far their biggest quarter EVER.

They guided to 7.5 million in Q2, which would make that their biggest Q2 EVER.

Corona Crisis is a godsend to Netflix and will accelerate their growth and dominant market positioning.

Obviously we all expected Netflix to exceed guidance this quarter. It was conservative to begin with and people around the world were ordered to stay at home. Some even predicted double digit subscriber additions, but nobody predicted 16 million. 

So why didn’t we see a huge rally in the stock price? In fact, it actually went down! 

A big (1) is management muted the good news by implying that Q3 and Q4 subscriber numbers would be lower due to a “pull-forward” of demand. 

(2) Streaming Wars competition is still a concern and 

(3,4,5…) questionable pricing power given competition, foreign currency headwinds hurting revenue and negative cash flow. 

Pull-Forward of Demand

This is a phenomenon that Netflix has been talking about for years; usually after they crush guidance, but I cringed when I read the following in the investor letter.

“Some of the lockdown growth will turn out to be pull-forward from the multi-year organic growth trend, resulting in slower growth after the lockdown is lifted country-by-country. Intuitively, the person who didn’t join Netflix during the entire confinement is not likely to join soon after the confinement.” 

They may be right, or they may not be. But, for the long-term outlook it doesn’t matter: People all over the world will continue to sign-up and pay for Netflix, because their price-to-value proposition is incredible and recession proof. 

Netflix now has over 180 million households paying for its service; so probably 3 – 4x that number of people watching. As more people join the Netflix ecosystem, Netflix will benefit from “network effects”, like Facebook. Meaning if all of your friends are talking about a particular show, you will feel compelled to also watch that show and participate in the social conversation. #TigerKing. #LoveIsBlind.

Well guess what? After the lock down a lot of people are going to be talking about Netflix shows, which will drive continued demand and new sign-ups. 

Corona Crisis is accelerating secular trends, including remote working, movie theater death and cutting the cable cord. All three actually bode well for Netflix. Globally consumers were already moving to streaming over cable and because of global stay-at-home orders we are seeing a mass acceleration in the global adoption of Streaming.

AT&T, Verizon and Comcast lost 1.5 million subscribers in Q1, while Netflix picked up 2.3 million in the US and Canada. Some haters even predicted Netflix would actually lose domestic subscribers in 2020.  

Streaming Wars Competition

Two areas must be mastered at global scale to compete with Netflix: Technology and Content.  

Amazon and Hulu are the biggest incumbent competitors but they’ve been around for many years and have not impeded Netflix growth. Also, worth noting Hulu is only available in the US and Japan. So who are the new entrants? 

• Disney+
• Apple TV
• AT&T’s HBO Max (or is Now or Go?…so confusing)
• Comcast’s Peacock

HBO and Peacock are “wait and see”. They’ll probably be ok, but the reality is (1) they are encumbered in profitable legacy businesses (broadband, cellular, cable TV, etc…) and therefore need to navigate corporate bureaucracy and innovators dilemma that will inevitably slow their path (remember Netflix is so focused they split off their DVD division and they have no other operating segments) and (2) they both lack a global technology infrastructure, one that Netflix has been building and optimizing for 10 years. 

Apple TV has the global technology infrastructure and they are off to a great start with original content. They also hired Richard Plepler the former head of HBO to a five year contract; a clear signal they are in for the long term and committed to quality. Their biggest issue currently is lack of content; most people would be hard pressed to name two original Apple shows. Nevertheless they will grow over time, but will be many years if ever that they are a substitute for Netflix. 

Disney+! 

This is the juggernaut that many expect to knock Netflix from their perch. They have global brand recognition and possibly the most valuable content library in the world (particularly when considering their acquisition of Fox). They have passed 50 million subscribers in less than two full quarters. Some question the authenticity of this number as many signed up free thru Verizon in the US and 8 million were automatic via their HotStar business in India. Nevertheless, it’s a meaningful number. 

Disney’s global technology infrastructure is weak and will slow global adoption. And while the Disney Corporation owns a lot of great content it is fragmented and licensed to local providers around the world making it difficult to simply “make available” on Disney+; which is why their catalog is thin. In fact, their catalog is largely kid’s content and some blockbuster movies from Marvel and Star Wars. (Pictured is the content they pushed to me via email last week…not exactly compelling). So in short, Disney needs to spend more building their technology and global distribution platform and they need to sacrifice profitability in the short term to build their streaming library and business.  

This is where Covid-19 comes in like a wrecking ball. Think about Disney’s big businesses where the profitability comes from: 

• Disney theme parks are closed. 
• Disney cruise ships are docked. 
• Movie theaters are closed.
• Network advertising down significantly.  
• ESPN has no sports.

Disney has gone from Streaming Rookie of the Year to a company that literally could be battling to survive the next few months. 

Covid-19 won’t kill Disney, but it’s mighty painful. 

Other Headwinds Mentioned Above

Cash Flow. Important to acknowledge here is Netflix management (Reed) chooses to be cash flow negative in order to accelerate global expansion and dominant position. This has been a smart move. Finally though, and somewhat a nod to nagging investor concern, Netflix has stated and confirmed that 2019 was peak negative cash flow. Now it’s possible that during 2021 Netflix will flip to positive cash flow, causing a number of value investors to come into the stock and drive up the price. (Netflix actually had positive free cash flow in this quarter, but it’s due to shutdown of productions, which by the way should have no effect on 2020 slate).  

Pricing Power. This is a valid concern, but as long as Netflix incrementally improves the service they’ll be able to slowly raise prices over years. Think about this: A $1 increase in price globally generates over $2 billion of annual revenue.

Foreign Currency. Can’t do much here. But the negative short-term impact came from US Dollar strengthening during this global crisis. We’ll likely see foreign currencies strengthen when this is behind us. 

Conclusion

Back in July 2018 Netflix stock price hit $419. So here we are almost 2 years later and the stock floats around the same level, but with 60 million more subscribers and an even more dominant market position. 

My guess is that 2020 will be a record year of subscriber adds and new Netflix stock highs and more great original content! 

Thank you Netflix for providing some much needed relief and entertainment in these times! 

No doubt this is a scary time. This isn’t just a financial crisis, like 2008-09, this is a global health crisis crippling our economy. We are reminded daily of:

• New corona virus cases and deaths
• Reports of hospitals full and running out of supplies
• Unemployment rising and companies running out of money. 

This is all real and should not be minimized. 

However, we also need to recognize that we are making great progress and this will all end at some point. Our financial and economic engine is intact and when we neutralize the corona virus our economy – and stock market – should snapback relatively quickly. There will be some financial restructurings for sure, but restaurants and stores will reopen, people will go shopping, start travelling and return to work.  

Today New York announced the closing of all non-essential business and yesterday California announced state-wide stay-at-home provisions (many states will follow this weekend). These are necessary and very effective ways to mitigate the spread of the corona virus. This is good news that demonstrates we are taking this threat seriously and addressing it head-on. I hope that we’ll look back and say we over-corrected; certainly better than not doing enough.  

If you’re interested in some good news: 

• China Hits a Coronavirus Milestone: No New Local Infections. A lot of caveats here: can we trust the data? Will the virus reappear as society moves back to normal? Nevertheless it is directionally HUGE. You can trust Starbucks and Apple, right? And they say their stores are open.  
• Coronavirus spread is slowing – Says Israeli Nobel Laureate. 
• Testing availability is picking up in the US, though still inadequate.  
• US Government has demonstrated willingness to spend in the Trillions $’s to support economy. 
• Christian Dior is making hand sanitizer and Tesla is working on ventilators. This may be more “feel-good” than game changing, but society is stepping up to the challenges.
• Search for Coronavirus Vaccine Becomes a Global Competition Governments and companies around the world are racing like never before to develop a vaccine and treatments for Covid-19. 
• Finally. I think it’s important to maintain some context. 
  • 176 Covid-19 deaths in the US as of March 19. 
  • 23,000 – 59,000 flu deaths from October 1 – March 14. The following graphic is from the CDC’s website: 2019-2020 US Flu Season: Preliminary Burden Estimates | CDC 

On to the markets.   

During the 2008-09 financial crisis US Stocks fell 56%. As of today March 20, US Stocks are down 33%. There were reports today in the news that some big spending billionaires like Buffet and Icahn jumped into the markets.  

Be Greedy When Others are Fearful, and Fearful when others are greedy – Warren Buffet

I love that quote. Way easier to say than do. History shows, systemic shocks to our economy are always followed by significant economic and market growth. 

It’s very possible this is NOT the bottom and the market will go down more. A lot of people will be quarantined at home worrying over the next 3-4 weeks. However, it is likely the market will be higher 12 months from now than it is today. 

Overall, the US Stock Market is down 34% (green line) over the last month. Our Big 3 trillion dollar tech companies: Apple, Amazon and Microsoft have held up remarkably well down between 15% and 30%. Netflix has really proved resilient only being down about 14% (makes sense right?).  

One way of thinking about all of this is these stocks, or the whole market is “on-sale”. Now they could get even cheaper, but the real question to answer is will they go up eventually? There are a lot of companies that are really cheap, like Zillow, down almost 60%. 

Also, this is a great time to fund long-term investments, like 529s and IRA. Maybe 401ks, but don’t fund too early and sacrifice employer match.  

Can’t wait to see what next week brings.  

Stay healthy and positive! 

A Company’s environmental practices will more profoundly impact cost of capital and investor returns.

Significant momentum behind investors voting with their wallets. Millenials have and will continue to lead this trend. 

It’s ok if you don’t know who Larry Fink is. Most don’t. He is the 67 year old white self-made billionaire CEO of BlackRock, a company that controls over $7 trillion of investments; only the US and China have annual GDP higher than that.

Each year he writes an open letter to CEOs’ — a presumptuous act in nature — but hey, here we are talking about it. In very short, his letter this year says: 

• Climate change is real and it’s a defining factor in companies’ long term prospects.
• Climate change is causing a fundamental reshaping of finance, AND 
• There will be a significant reallocation of capital as a result.

“Reallocation of Capital” is finance jargon meaning investors are beginning to prioritize environmental responsibility and sustainability over profitability. The responsibility of business is a question economists, business leaders and society have extensively debated during the last century, with the seemingly dominant capitalist position memorialized by Milton Friedman as: 

“There is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits.” 

Fink overtly states as example that Blackrock will be “exiting investments that present a high sustainability-related risk, such as thermal coal producers.” Jeez; sucks to be a coal producer I guess. In all seriousness though, you could be a profitable coal producer generating electric power for many homes and Teslas, and now business just got tougher and more expensive (will be harder to raise capital in theory). 

This isn’t just Fink. Also, this month, Tom Steyer emphasized in the democratic debates that fighting climate would be his number one priority as President. And Satya Nadella the CEO of Microsoft committed to eliminate Microsoft’s carbon emissions and invest $1 billion in climate initiatives. Microsoft actually cited the Xbox as one of its largest carbon footprints. Who would’ve thought? 

These are not entirely new concepts to finance. The Dow Jones began publishing in 1999 global sustainability indexes based on their environmental, social and governance practices (known as ESG criteria). Mr. Fink’s company Blackrock offers ETFs, for example, that are based on these ESG indexes and can even exclude businesses involving alcohol, tobacco, gambling, firearms and adult entertainment. 

We are in the midst of a paradigm shift in thinking: acknowledging that real-economic value can and will be derived from social impact. And we should go ahead and thank the millenials, led by Greta Thunberg 17 year old Swedish environmental activist and 2019 Time Person of the Year, for driving us here hard and fast.

Personally, I have not historically advocated an investment approach that is “environmentally conscious”. Not because I’m opposed to it, but more because I subscribed to the Milton Freidman and Adam Smith school of thought. And it just didn’t seem that practical: Do I boycott a company that uses styrofoam packaging? I’m now amenable to an ESG investment approach, because I think doing something is better than nothing and I believe there will be financial rewards. A good excuse to buy a Tesla as well.  

My point in all of this? We all think about the environment and debate climate change and global warming, etc… The difference NOW, is we are going to see a monumental shift in how capital is allocated. Or said another way the millennial generation is going to be much more serious voting with their wallets; and savvy investors recognize this. 
Questions relating to this column can be directed to Sean Hathaway, Investment Advisor and Manager; (971) 409-4180; or visit: www.HathawayFinancial.com

Slowing domestic (US) growth disappoints investors. International positioning is under-appreciated.

Advertising? No. And for good reason. 

Netflix will continue to grow steadily for many years, likely decades.

Stock Price: 

The stock needs a few things to stay on track and go to $500:

• Cash Flow needs to improve, i.e. 2019 better be “peak negative cash flow” as Reed declared in the earnings call. 
• Global subscriber growth needs to stay on track, i.e. 28m+ for 2020, and no more net decreases domestically.  
• Netflix needs another break-out hit along the lines of Stranger Things or better yet their ever elusive Game of Thrones. Could it be The Witcher? 

To really break-out, like $700+ in next 2-3 years: 

• New Subs: Need to accelerate past 30m subs per year. 
• Content: A must-see title in magnitude and zeitgeist of Game of Thrones, would help. Or a globally demanded film in the neighborhood of Star Wars or Avengers, but frankly very tough without existing IP. But it can be done: Titanic, for example. 
• China: Open for business. 
• Sports. For the US they likely could grab a significant cohort of non-subscribers with high demand sporting events like Sunday or Monday night football. Or possibly Nascar, which is more congruous to no commercial format. Globally, something like the World cup, cricket or tennis.

Subscriber Growth

Netflix reported Q4 2019 earnings this week, including record revenue of $5.5b and 167m global subscribers. However, US sub growth of 0.5m, disappointed, as it was down from 1.2m in Q4 2018. 

Netflix has penetrated 60-70% of US Broadband households, reaching a point of saturation, and facing headwinds from new streaming competition of Apple and Disney in Q4 and HBO/AT&T and NBC/Peacock coming in 2020. The fact is Investors weigh heavily US performance, because the US is a reasonable indicator of potential growth in foreign markets. 

Why is US Sub-growth slipping? It’s getting incrementally harder to acquire each new sub. 

But consider this… 

For every $1 Netflix spends there is an opportunity cost, and it’s not the same opportunity US competitors have. Netflix must choose how to allocate their spending regionally. For example,  say they are hypothetically debating to spend $500m in marketing and content in either the US or International. Maybe that $500m spent in the US gets 400,000 new subscribers, but spend it in EMEA or APAC and it gets you 1,600,000 subs. They should choose the latter, and generate more cash. This analysis is over-simplified, but it’s illustrative. 

As an investor, I’d love to see domestic subs growing more, but on the other hand, I’m glad investment is being made with cash generation and international growth in mind. 

Here’s a bigger theoretical question: Given $500m who can allocate that more efficiently to generate revenue? Apple, Disney, Peacock, Netflix? My bet is on Netflix, because of their global scale and platform; hard to prove, but time will tell. For example, when Netflix spends on a great piece of content, like Stranger Things, not only does that benefit US demand, but subs in Vietnam and France are signing up.  

That all said the more concerning point is that total sub growth in 2019 was 27.8m, about 1m less than 2018. However, it must be noted that year-over-year Netflix increased average global pricing by 5%, which also created a headwind for decreased subs. Netflix will have less pricing power in the US for the next couple of years until this competition shakes out a little.

International 

The international penetration of streaming that Netflix has achieved and will continue is under-appreciated. Disney, Amazon, Apple will figure it out, but it will take years. (I’m more skeptical of Peacock and HBO figuring it out). 

Consider this: Netflix is producing 130 series of local language television in 2020. And local originals were the most popular 2019 titles in many countries, including India, Korea, Japan, Turkey, Thailand, Sweden and the UK. Further in order to scale US and local titles across the platform Netflix is commonly dubbing into nine languages: French, Italian, German, Turkish, Polish, Japanese, Castilian Spanish, Latin American Spanish and Brazilian Portuguese, and it offers subtitles in 27 languages. WHAT!? Subtitles in 27 languages is not an easy feat when you consider not only the language/artistic effort, but the technology and infrastructure required behind the scenes to make that work. 

When I watched the Newsroom on Apple (a really great show by the way) the English Audio and subtitles were screwed up on parts. 

Advertising 

Every quarter it seems Netflix Management reiterates they don’t expect to start advertising, but this quarter Reed offered some enlightening – arguably intuitive – thoughts. Advertising is not easy money. Amazon, Facebook and Google have become the most powerful effective advertising machines in the world, partly through their insidious collection and utilization of user data. With the exception of viewing, Netflix does not collect user-data. These big 3 are getting better every day and Netflix would have to compete with them. Obviously, Netflix could attract some advertising dollars, from linear TV for example, but would it really prove profitable. And at what expense? 

Netflix benefits from not being embroiled in user data scandals and government inquiries. So in short: (1) Contrary to popular belief it is not easy to monetize from advertising and (2) because there is no personal data collection – save viewing – Netflix is a more comfortable and “safe” place for users. 

Conclusion

In the long-term, investors’ demands are simple: more subscribers, revenue, profitability (check, check, check) and particularly in the case of Netflix, more positive cash flow. We’ll see on the last one. 

Netflix’s international growth opportunity is tremendous and they will continue to grow significantly for years to come. The professionals that work there are extremely smart and determined, and so will continue to solve the puzzle of US subscriber growth. So while US growth has slowed, it will not stop.

About 10 years ago Netflix started “streaming” and since then we are seeing a monumental historical shift in TV viewing from the cable advertisement supported model to on-demand streaming. This shift in viewing is happening globally and will continue for many years. Netflix is on the frontlines and leading the charge Content-wise and technologically.  

Netflix will not stop growing Revenue any time in the next two decades, probably more. In thinking about the stock price growing it’s not a matter of if, but simply when. 

Sean Hathaway is an Investment Advisor and Manager at HathawayFinancial.com