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hey it's tom here and welcome back to the channel now this has been a very very big week for netflix investors uh we had netflix come out and report their first quarter 2022 earnings as well as providing some updated guidance for the netflix business moving forward and the market really did not like the earnings update from netflix at one point during this week the stock price was down 35 in a single day and uh to my surprise very quickly after those earnings results came out we actually also had a press release out of pershing square which is bill ackman's fund his money management vehicle i guess and uh after only investing in netflix in late january bill ekman has actually turned around and fully exited the netflix position he's sold all the shares that he owns through pershing square and it's really interesting i think as a case study to read through some of the initial reasons why bill ekman got into netflix and also some of the updated reasons why he has now gotten out so in this video i want to give some of the results that actually came out of netflix which were effectively slower revenue growth and projecting slower growth moving forward and some of the reasons why they think that's happening and kind of what netflix investors should expect moving forward and uh secondly i want to talk through uh what bill ekman actually came out and said initially in january when he made his investment in netflix and more recently what he thinks has changed in the story and caused him to sell now if you want kind of my personal thoughts on netflix as a business and a potential investment case i won't be covering that in a huge amount of detail in this video uh but i was recently on the young investors podcast with brandon from the new money youtube channel and also hammershotter from the hammer shoulder youtube channel so that podcast with brandon hamish has just been released as i'm recording this video so i will leave a link down in the description below if you want to check out a video version uh it's called the young investors podcast uh if you want to search that up on audio platforms as well but uh without further ado let's get straight into the video with an update from netflix and also bill ackman okay so i'm going to start off with the shareholder letter from netflix and the shareholder letter basically gives sort of four reasons why netflix thinks the revenue has or revenue growth at least has started to slow and it also gives some of the kind of stats in terms of subscriber numbers and revenue and and so on so let's start there and the shareholder letter begins by saying our revenue growth has slowed considerably as our results and forecasts below show streaming is winning over linear as we predicted and netflix titles are very popular globally however our relatively high household penetration when including the large number of household sharing accounts combined with competition as creating revenue growth headwinds the big covert booster streaming obscured the picture until recently while we work to re-accelerate our revenue growth through improvements to our service and more effective monetization of multi-household sharing we'll be holding our operating margin at about 20 percent key to our success has been our ability to create amazing entertainment from all around the world present it in highly personalized ways and when more viewing than our competitors these are netflix's core strengths and competitive advantages together with our strong profitability we believe we have the foundation from which we can both significantly improve and better monetize our service longer term and if we look through some of the uh core kind of business results for the first quarter of 2022 uh this is where basically those figures came in at so uh year-over-year growth in revenue was up nine point eight percent uh for the first quarter of 2022 versus the first quarter of 2021.
operating income came out at 1.972 billion operating margin of 25.1 net income of 1.6 billion and earnings per share of three dollars and 53 cents per share now uh the bit that really caught a lot of netflix investors by surprise is actually this next part so uh global streaming paid memberships uh basically netflix subscribers it's a figure that netflix investors clearly pay a lot of attention to uh the netflix business model is reasonably straightforward it's how many subscribers do you have and what price are those subscribers paying basically and the subscriber number actually shrunk from last quarter for the first time in netflix's history now there's an important caveat to that which i will get to in a sec but the numbers came in at 221.64 million uh global streaming paid subscribers versus the previous quarter so fourth quarter 2021 it was 221.84 million so they've lost about 200 000 subscribers since the uh fourth quarter of 2021 and i think the uh part of this that actually surprised netflix investors even more was the guidance that netflix gave for subscriber numbers next quarter so for uh q2 2022 they are guided to have 219.64 million paid memberships which would be a decrease in subscribers of two million for the next quarter now firstly let's touch on the important caveat uh for the decrease in subscribers for uh the first quarter of 2022 where they've lost 200 000 subscribers a lot of that is basically to do with netflix pulling out of russia so they've completely stopped kind of the streaming services in russia and that had a negative uh 700 000 subscriber impact on the business so uh you've lost 700 000 from russia they've lost 200 000 overall for the quarter so that means uh if you kind of adjust for russia they've actually grown subscriber numbers by about half a million in in the first quarter so that is a very important note when you're looking at those subscriber numbers and this is the commentary they gave on that sort of two million subscriber decrease for next quarter so they said as a reminder the quarterly guidance we provide is our actual internal forecast at the time we report for the second quarter of 2022 we forecast paid net additions of negative 2 million versus 1.5 million in the year ago quarter our forecast assumes that our current trends persist such as slow acquisition and the near-term impact of price changes plus typical seasonality q2 paid net ads are usually less than q1 paid net ads we project revenue to grow approximately 10 year-over-year and q2 assuming roughly a mid to high single digit year-over-year increase in average revenue per membership on a foreign exchange neutral basis we still target a 19 to 20 operating margin for the full year 2022 assuming no material swings and foreign exchange rates from when we set this goal in january of 2022.
so an important note there is that uh yes netflix do expect to have some struggles i guess in terms of growing their subscriber base uh in the immediate future but they do still expect revenue to grow and that is basically a function of price increases so like i said business model at netflix is pretty straightforward at least in terms of how they generate revenue you have a certain number of subscribers and you have a certain price per subscription and uh i would argue that netflix still have a fair amount of wiggle room to keep pushing that kind of price per subscription up particularly if you consider just how kind of penetrated their business is in the us which is more or less if you account for household sharing which they do get into in the shareholder letter uh you've got very very high penetration rates in the us like um it might as well be every household that has an internet connection it's not quite that extreme but uh it's getting pretty close to that level okay now before we get into uh what bill ekman did with his investment in netflix and what he kind of said about exiting the position uh let's very quickly walk through the four factors that netflix described that they think is starting to impact their revenue growth so they said first it's increasingly clear that the pace of growth in our underlying addressable market broadband homes is partly dependent on factors we don't directly control like the uptake of connected tvs the adoption of on-demand entertainment and data costs we believe these factors will keep improving over time so that all broadband households will be potential netflix customers second in addition to our 222 million paying households we estimate that netflix has been shared with over 100 million households including over 30 million in the u.s and canada region account sharing as a percentage of our paying membership hasn't changed much over the years but coupled with the first factor means it's harder to grow membership in many markets an issue that was obscured by our covert growth good competition for viewing with linear tv as well as youtube amazon and hulu has been robust for the last 15 years however over the last three years as traditional entertainment companies realized streaming as the future many new streaming services have also launched while our us television viewing share for example has been steadily up according to nielsen we want to grow that share faster higher view share is an indicator of higher satisfaction which supports higher retention and revenue and fourth macro factors including sluggish economic growth increasing inflation geopolitical events such as russia's invasion of ukraine and some continued disruption from covert are likely having an impact as well now if you then go on to listen to the conference call that netflix did which i would definitely recommend listening to if you have any interest in potentially investing in netflix and particularly as the price has gone down i don't personally have a position on netflix and you know don't buy or sell it just because i'm saying things out to you and work on it but in the conference call they did say a couple of things that were quite interesting so firstly they mentioned that they've never really been that worried about household sharing of passwords and things uh they felt that it was actually quite a good marketing tool for people to get some initial exposure to netflix and then potentially go on to subscribe themselves when they no longer have access to friends password or whatever but now they're getting to the point where that account sharing is really limiting the growth if you uh include the estimated number of households that are kind of borrowing passwords there's really not a whole lot of uh total addressable market left to grow into so that's something that they're interested in potentially cracking down on although there are some substantial challenges with actually verifying like who's a family member and who's not and it's interesting to get some management commentary on that so i definitely go and recommend checking out that that conference call and uh the other thing that they kind of just floated the idea of um which reed hastings the ceo says he's never particularly been a fan of but he's a bigger fan of consumer choice basically and that was potentially looking at bringing out a netflix subscription tier option that actually has uh advertising and that would be at a cheaper price than the traditional netflix subscription he said that's probably not something that's going to be out at least within the next one or two years but it is an option that they're looking at as well okay now for the second part of this video like i say i want to take a look at basically what bill ekman has said about uh netflix uh i will cover a few of his points from his uh she held a letter in january when he first made a position in netflix and uh we will kind of cover what he has said in a recent update about why he has turned around and sold netflix now time of course will tell whether this was a good decision or a poor decision for blackman but i think it's a really interesting case study of kind of bill ekman really wanting to focus on highly predictable businesses and basically positioning himself accordingly in his portfolio you may or may not agree with what he's done but it's certainly an interesting case study so let's go back to his letter from the 26th of january 2022 where he described netflix's business has highly favorable characteristics and he gave kind of a list of the reasons why he was getting invested so he said it's subscription-based highly recurring revenues which have enormous future growth potential a truly best-in-class management team and unique high-performance culture economies of scale and superb quality and its industry-leading content which should continue to drive future growth and widen the company's powerful competitive moats pricing power derived from the enormous value it delivers to consumers compared with other alternatives substantial margin expansion with the opportunity for continued improvement due to economies of scale and the company's rapidly growing global subscriber base and finally an improving free cash flow profile which should allow for continued investments and growth as well as the return of cash to shareholders so what changed with netflix now this is what bill eckman had to say in his most recent update on the 20th of april 2022 and as usual all of these press releases and shareholder letters and things will be linked down in the description below so bill ekman said today we sold our investment in netflix which we purchased earlier this year the loss on our investment reduced pershing squares year-to-date returns by four percentage points reflecting this loss as of today's close the pershing square funds and down approximately two percent yet a date while we have high regard for netflix's management and the remarkable company they have built in light of the enormous operating leverage inherent in the company's business model changes in the company's future subscriber growth can have an outsize impact on our estimate of intrinsic value in our original analysis we viewed this operating leverage favorably due to our long-term growth expectations for the company yesterday in response to continued disappointing customer subscriber growth and netflix announced that it would modify its subscription-only model to be more aggressive and going after non-paying customers and to incorporate advertising an approach that management estimates would take one to two years to implement while we believe these business model changes are sensible it's extremely difficult to predict the impact on the company's long-term subscriber growth future revenues operating margins and capital intensity we require a high degree of predictability in the businesses in which we invest due to the highly concentrated nature of our portfolio while netflix's business is fundamentally simple to understand in light of recent events we have lost confidence in our ability to predict the company's future prospects with a sufficient degree of certainty based on management's track record we would not be surprised to see netflix continue to be a highly successful company and an excellent investment from its current market value that said we believe the dispersion of outcomes has widened to a sufficiently large extent that is challenging for the company to meet our requirements for a core holding one of our learnings from past mistakes is to act promptly when we discover new information about an investment that is inconsistent with our original thesis that is why we did so here we are in the midst of an opportunity-rich environment for pershing square due to the dramatic shift in federal reserve policy the highly inflationary environment geopolitical uncertainty and the resulting high degree of security price volatility we therefore expect to find a good use for the netflix proceeds so for me uh two really interesting takeaways from that letter from bill eckman the first thing that he really highlights is operational leverage and the second thing that he really highlights is basically uncertainty now in terms of operational leverage uh this is something i've been thinking of doing a video on actually recently so if you're keen to see me do a more detailed video on operational leverage definitely let me know but operational leverage is essentially the idea that if revenue grows or if revenue shrinks the profitability of the business uh moves to a much greater degree so if revenue goes up five percent for example you know earnings might go up fifteen percent and if uh revenue drops five percent maybe earnings go down twenty percent you're kind of leverage to whatever the operations of the business are bringing in terms of revenue and this is very typical to see and a lot of kind of subscription based businesses we have a large kind of fixed cost base there's not a huge amount you can do to move those costs significantly up or down year to year and you kind of get to a point where every new subscription coming in the door is essentially kind of pure profit so that can really dramatically improve margins and provide operating leverage as bill ekman described it so small changes in future growth for netflix and the revenue that's coming in the top line can have an outsize effect as he described it on the earnings and intrinsic value of the business so that's something that really stands out to me um personally as a netflix subscriber i i've just kind of i see the money just disappear from my bank out every month and it's probably one of the last things i would cancel i don't often watch like standard tv anymore i kind of just watch netflix and youtube and things so um for me i'm definitely a sticky customer and if the price goes up i probably won't cancel if i've been perfectly honest with myself um but that's just me perhaps it's becoming clearer that other people don't have that same attitude to netflix but uh i'd potentially also argue that if if netflix isn't a sticky product then you know what should we expect to happen to basically every other consumer business on the planet you know i would argue netflix is one of the stickier products up there but that was kind of the first point from blackman uh the second one is uncertainty and just a wider range of outcomes than uh we've had before and um investment is very much kind of a probabilistic exercise there is never certainty when you make an investment unless you're investing in you know a government bond or something where they can print money and never go bankrupt and all that sort of stuff um you know anytime you're investing in a company which is what you're doing when you buy a stock there is a degree of uncertainty and there are a range of outcomes each with varying probabilities and your job as an investment analyst is to try and get a handle on what is the probability of each of those outcomes uh how much will i lose and the bad outcomes how much will i make and the good outcomes and if you're comfortable that you can assess those odds with you know a degree of certainty and you're comfortable that the risk reward is attractive uh then you will make the investment that is how bill ekman is clearly thinking about it um as i understand it that's exactly how warren buffett and charlie munger think about investment and uh we've also seen people like moses brian talk about that approach to investment as well where if the downside is limited the upside kind of tends to to take care of itself so clearly due to this slow growth from netflix uh bill ekman thinks that the odds have changed and they've changed to a significant enough extent to where he is basically exiting netflix having learnt from potentially some prior mistakes that he may have just held onto a business too long and it really didn't work out well so that's it for me for this one uh definitely let me know your thoughts on the netflix update uh whether it's a business you're getting interested in or whether it's something you're just not interested in at all and let me know your thoughts on bill ackman's kind of change of attitude towards netflix as well down in the comments below so that is really it for me for this one i do hope you enjoyed the video if you did please hit like and also subscribe to the channel if you are new here and i will see you in the next video cheers
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