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Pershing Square's Bill Ackman Buys The Weaker Streaming Play

James Chapter 1 verse 5 states, "If any of you lacks wisdom, you should ask God, who gives generously to all without finding fault, and it will be given to you."


I tend to selfishly look to God for what I want. The verse above alone can seem to appease this desire. But the reality is that God loves me like a father loves a son or a daughter. He knows what is best for me and desires it. As such, God's blessings to be given to me are not a result of appeasing my desires, but rather my desires fitting into His will for my life.


For investing, it is very challenging to attempt to manage a portfolio of equity holdings, especially with respect to aggressive growth goals and objectives. Similarly as I need to fit into God's will to obtain His generous blessing, in order to manage an aggressive growth portfolio successfully, I need to adapt the portfolio within the market's extreme volatile tendencies. Picking winners among the thousands of investment options isn't a 1-2 year plateau, but instead takes 5-10 year increments to measure true success.


By now many are aware of Pershing Square Capital's decision to acquire 3.1 million shares in Netflix, Inc. (NFLX). I am of the opinion that taking a large stake in Roku, Inc. (ROKU) would have been the better streaming investment play.


Pershing Square has never owned Netflix prior to this move. Pershing Square Tontine Holdings (PSTH) also failed miserably with Mr. Ackman's endeavor to successfully compete within the SPAC market over the past couple years. I see these two facts as strong red flags for the recent move.


Let's take a look at Pershing Square's justification points and deployment of capital:

Netflix is a primary beneficiary of the growth in streaming and the decline in linear TV driven by its superior customer experience, a vast and diverse amount of superb, constantly refreshed content, global improvements in bandwidth, and the proliferation and continuous improvement and convenience of devices on which one can watch.

Netflix is actually witnessing intensifying slowing growth that, combined with only modest pricing power to increase monthly subscription costs, will lead to overall lower performing Revenue results. The big issue here is that content spend will likely grow at a higher rate, placing mid-term pressure on Cash Flow capabilities.


Put another way, I am modeling Netflix to grow global average paying memberships by a little over 12% annualized through 2026, with average monthly paying membership growing below 2%, equating to an average 14% Revenue growth rate per year. This does place Netflix on a path towards $60 billion in Revenue by 2027, but I assume that the majority of the next five years will see Cash Burn and a modest 1-2% Operating Cash Flow, OCF margin over the mid-term. Netflix business model is the antithesis of the former media conglomerate Cash Cows.


Netflix will also chase online gaming as it has already stated its ambitions. This will connect directly with the Metaverse that is gaining steam, no pun intended. I see major mid-term risk for the company based on both Cash Burn from its streaming business and further Debt dependence regarding either intensified Cash Burn from devoting internal development for online gaming, and/or acquisitions, ala Microsoft Corporation (MSFT).

We began analyzing Netflix in connection with our investment in Universal Music Group, so we were prepared when the stock price declined sharply last Friday. Now with both UMG and Netflix, we are all-in on streaming as we love the business models, the industry contexts, and the management teams leading these remarkable organizations.

UMG....... has been a disaster for Pershing Square. Let's simply take a look at SPAC bag holders.

Warrants have been much, much worse.

Mr. Ackman was drawn to the allure of the SPAC craze thinking that he could land the best of both worlds - growth and scale. He touted such opportunities as Palantir Technologies (PLTR), Airbnb, Inc. (ABNB), and Stripe, Inc. among others. Instead of closing on any of them, he instead expressed statements of why they weren't a good fit, or ready to go public. This was code for getting denied.


The UMG focus and outcome is a clear indication of Mr. Ackman's rather interesting risk-risk/averse nature. Investing in companies like Netflix and UMG is essentially taking a very conservative approach to tomorrow's innovation and future growth leaders, both not equating to this. It takes risk to innovate and push forward, and these two companies are not the best candidates for tomorrow's streaming future. This is evidenced by the former being a slowing growth play and the latter being a legacy-based company attempting to pivot.

In order to fund our purchase of Netflix, beginning on Friday and over the last few days, we unwound the substantial majority of our interest rate hedge generating proceeds of $1.25 billion. We retained interest rate swaptions that are currently out-of-the-money, and also purchased some additional longer-dated, out-of-the-money swaptions. The result of all of the above is that the notional size of our interest rate hedge has been reduced by 80%, the term of a substantial portion of the hedge we retain has been extended, and our dollar investment in hedges has been reduced by more than 90%

I like the transparency, but man, Mr. Ackman essentially invested in Netflix, let's just say in the $370s on average over the past four days, upwards of $1.1 billion to get his 3.1 million shares. He could have instead purchased Roku with 3.1 million shares for less than $500 million, and added another stronger growth peer to boot.


If you ask me, I believe that Mr. Ackman is looking for a conservative double that can be pumped towards the exit strategy. Netflix has never really traded on any credible valuation metric since transitioning full throttle into streaming. Make no mistake, I believe that their execution was the right move from the DVD business, but they have only proven that their streaming model cannot generate a return on investment. Aside from the pandemic creating a skewed operating year, Netflix has only been able to generate positive OCF by benefiting from monthly subscriptions and severely reduced content spend.


Roku on the other hand continues to witness Cash Flow inflection, with Revenue growth vastly outpacing Netflix's performance. To put this simply, Netflix is on track to grow annualized subscription costs from $136 to $150 per year over the mid-term based on my estimates. While a company like Roku is seeing annualized Revenue per user growth from $40 to $100 over the same period. Roku's ARPU is more diverse than Netflix's subscription-based model, and a testament to a much stronger Return on Investment, ROI.


Analysts have flipped the script against Roku claiming that their addressable market is now questionable. There are competitive pressures against Roku, but ironically Netflix was faced with a similar situation early in its DVD business model as well. If it's any indication, Roku has successfully navigated challenging contract agreements with such stalwarts as Comcast Corporation (CMCSA), At&t, Inc. (T), Apple, Inc. (AAPL), and Alphabet, Inc. (GOOG) over the past year, with Amazon, Inc. (AMZN) looming this year. Roku has also taken a no-name brand Smart TV in TCL to the number one market share in North America. Analyst banter of Roku not breaking into "Tier 1" markets with Samsung and others being a concern over addressable market is a weak argument as Roku's brand recognition is exponentially stronger and much more proven today.


Buying Netflix in the $360 range isn't a bad risk/reward play at all. I think that it is reasonable to expect an annualized investment return for Netflix of 12-18% from this level over the next five years depending on how they execute. But when it comes to streaming and future opportunities, Roku is a much better pick, that is poised to generate an annualized investment return, double that of Netflix. Netflix popped after-hours on the news, but I chalk this up to a conservative play by Mr. Ackman. And, judging by his stock picking performance over the past few years, and aside from his investment hedge moves, there's a lot more questions than confirmation on his ability to pick winners. I wouldn't recommend investors pile into Netflix based on Mr. Ackman's recent disclosure. Especially if investors are interested in identifying market leaders defined by growth rates and Cash Flow performance. Based upon the metrics that matter, Roku is the better investment.





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