The Update Issue: A Tale of Two Meltdowns - Netflix and Peloton

On Monday, I discussed how volatile times could be a good catalyst for a portfolio review... When markets move up or down quickly – or just start to gyrate extra violently – it's a good sign that something has changed. Big, fast moves up mean that it may be a good time to take profits... […] Not rendering correctly? View this e-mail as a web page [here](. [Empire Financial Daily] The Update Issue: A Tale of Two Meltdowns - Netflix and Peloton By Berna Barshay On Monday, I discussed how volatile times could be a good catalyst for a portfolio review... When markets move up or down quickly – or just start to gyrate extra violently – it's a good sign that something has changed. Big, fast moves up mean that it may be a good time to take profits... even if just on a portion of a position. Big, fast moves down mean you should consider buying more if nothing has materially changed with a company's outlook. Or a big plunge could alternatively be a waving red flag that an initial thesis was flawed, and you should cut your losses. Market experts often advise you to double down when a stock falls for no reason... But if you are fully invested, you can't increase your position in one stock without reducing your position in another. So, to take advantage of volatility and turn lemons into lemonade when that volatility is to the downside – you need to take a cold, hard look at each stock in your portfolio and determine if you were going to do it all over... would you buy it again today? In [Monday's Empire Financial Daily]( I shared two questions that I ask myself when doing this kind of portfolio review. They are: - Is this a solid company? - Is the price today a reasonable one to pay for this stock? There are a bunch more things that I ask myself to get to the answers to these headline questions... but I will refer you back to the original piece for details, so I'm not too repetitive here. Putting the big questions to the test in a tale of two meltdowns... You may have heard that streamer Netflix (NFLX) and home fitness company Peloton (PTON) had a bit of a rough end to last week. NFLX shares dropped 22% on Friday in the wake of extremely disappointing new subscriber guidance. They continued to slide another 10% during the first three sessions of this week until the announcement today that hedge fund billionaire Bill Ackman had taken a big new stake in the company stopped their slide. Shares are up 8% today, almost back to last Friday's close. PTON shares were down 24% on Thursday on press reports that the company had temporarily stopped production on bikes and treadmills, indicating that demand continues to drop in the face of an inventory position we already knew was bloated from last quarter's reporting. Peloton also attracted an activist investor. Earlier this week, Blackwells Capital began agitating Peloton's board to put the company up for sale and fire CEO and co-founder John Foley. This activist showing up turned around the stock for a couple of days, but PTON shares are making new lows today. Let's go to the two questions. First, up – Netflix. --------------------------------------------------------------- Recommended Links: [REPLAY AVAILABLE: Whitney Tilson's Most Important Event Yet]( Experts like Leon Cooperman and Stanley Druckenmiller have issued dire financial warnings for 2022. This is why Whitney Tilson met with three of the brightest financial minds in the country to a panel discussion last night. And it could have a HUGE impact on your wealth, beginning immediately. [Check out the replay right here](. --------------------------------------------------------------- [Why most people miss the biggest tech gains]( Amazon, Microsoft, and Google all have a secret. If you'd known about it, you could have made millions. But most people don't know it even exists. Today, we're pulling back the curtain. [We reveal everything right here](. --------------------------------------------------------------- NFLX shares gave up around two years of gains when they plunged last week...  Netflix is no doubt a solid company. In fact, it's an incredible company. It is the leader in streaming video worldwide, is racking up awards for its content, has an amazing management team, and boasts generally happy customers. It easily checks the box on question No. 1. The trickier question to answer with Netflix is No. 2. Determining whether its price is reasonable is inextricably related to determining if expectations are reasonable. I've been negative on NFLX shares for over a year because it had a big valuation – an enterprise value to earnings before interest, taxes, depreciation, and amortization ("EV/EBITDA") ratio of more than 35 times, before its big drop. But the valuation in isolation wasn't what had me on the sidelines for a company that I admire. It was that valuation, when paired with expectations that I viewed as unrealistic. Part of why people were paying so much for Netflix was big expectations about net subscriber adds and operating margin expansion. But the pandemic was an unprecedented customer recruitment event... and Netflix bulls had unrealistic expectations about near-term growth going forward after this big pull forward of future demand – and they bid it up too much. At $500 or $600, it was a good company but a bad stock. Trading below $400, the valuation is much more reasonable. Its EV/EBITDA ratio on 2023 estimates is now less than 20 times. But it's not just the valuation that has changed... it's the expectations. Consensus estimates for 2023 EBITDA are down 12% from a month ago. EBITDA expectations for this year are down even more, 16%. Last Thursday's earnings shock was a tremendous wake-up call for investors who had been too complacent about the smooth, linear pace of Netflix's growth trajectory when it came to subscribers, revenues, and operating leverage. There was also too much complacency as well about how growing competition would impact the market. Now the pendulum of sentiment has probably swung too far the other way... People think Netflix has gone ex-growth... I disagree. But we are looking at lumpier growth for Netflix, with more uncertainty about how profitable new subs will be. The hiccups Netflix has recently experienced in India are a good reminder that while there are more than 4 billion people out there globally who have Internet access but aren't Netflix customers, the vast majority of them cannot afford anything close to $15 per month for the service. That said, I think we are in the early innings for streaming globally, even if we are in the later innings for Netflix in the U.S. and Canada. There are still big unanswered questions, most importantly: Will Netflix ever generate substantial and meaningful cash? Because of the vagaries of entertainment accounting, Netflix can post earnings but still burn cash because a lot of production costs are capitalized. Netflix's ability to print profits but not cash is intrinsically related to the competitive environment. I've written about the streaming wars a bunch, and one of the main features of this battle is ever-escalating content spending. I have been arguing for the need for industry consolidation for a long time. If we could get to just three or four major, global video streaming companies... I think the free cash flow picture would look a lot better. So in Netflix's case, the answer to question No. 2 is that yes, the stock is more reasonably priced, and just as importantly, expectations are more reasonable. For long-term holders, I think NFLX shares are a good buy here under $400. Shares could be range-bound for the next year or so, but if you are playing for the long-term, I can finally say "good company, good stock." But you must be willing to be patient. Over at Peloton, there was a huge pull forward of demand as well... Perhaps the most amazing thing about the crash in Peloton is that it has left PTON shares trading below where they were in February 2020, before the pandemic hit...  This price action is stunning. Pre-pandemic, Peloton had yet to prove it could be profitable. In the three (mostly) pre-pandemic quarters ending March 2020, the company lost $1.45 in earnings per share ("EPS"). In the first three quarters after the pandemic began, from April 2020 to December 2020, EPS flipped positive and clocked in at $0.69. That big swing should have gone a long way to proof of concept for Peloton. But with it falling deep into the red again by the time the June and September quarters rolled around in 2021, it's natural to ask if profitability was a sustainable state at Peloton. But let's turn to the big questions... When you ask yourself the first question... Yes, this is a good product, for sure. Anyone who is a Peloton user will tell you that... and churn of only around 2% annually for connected users is a good piece of evidence. But the product is just one piece to answering the question about whether or not you are looking at a good company... So, is Peloton a good company? Management has done a terrible job controlling inventory, managing finances, forecasting demand, and a million other things. One thing I look at is the bloat on the operating expense line. This number was around $800 million in the four quarters preceding the pandemic. In the last four quarters, it has exploded to almost $1.8 billion. Research and development, which ran under $100 million annually before the pandemic, is now running over $300 million... I can't even begin to guess what it is spending that money on... Another huge red flag is the lack of truthfulness and good judgment from management. They said they didn't need to raise capital and then had to issue equity a few weeks later. Who is doing their forecasting? That's a judgment problem. But the truthfulness problem is even worse... CEO Foley was quick to issue statements saying the rumored production pause was not true. Yet, a few days later, Business Insider obtained internal company documents confirming the planned pause...  Source: Business Insider Once a company starts lying – or going on a witch hunt for "leakers" – as Foley did in his memo, the company has jumped the shark, at least with current management in place. Peloton decidedly fails question No. 1, at least with its current leadership. There's no point in even trying to answer question No. 2 if a company fails question No. 1. But since it is pretty easy to answer on a high level, I will share some thoughts. The million-dollar question now regarding Peloton is the total addressable market ("TAM"). Like Netflix, there were big expectations. Given the sudden and violent demand slowdown, the big question is whether Peloton can return to growth after its pandemic hangover is done... It pulled forward years of growth, but is there more growth behind that? I suspect Peloton can be much bigger than it is now – but nowhere near what the bulls had imagined. These oversized expectations created an overvalued stock. If you buy NFLX shares here, I think you will make money with a long enough timeline. I'm not sure I can say that with confidence about PTON shares. I would continue to avoid PTON shares... They are not ownable with this management team, and I am skeptical that there is a strategic buyer out there at the current valuation of around $8 billion. At $2 or $3 billion, maybe... but that's a lot lower than there. In the mailbag, a question about environmental, social and governance ('ESG') investing and more reactions to last week's piece on nuclear power... Did you start or add to a position in Netflix or Peloton on the big drops? Or did you dump either of them? What's your outlook on these two stocks? Share your thoughts in an e-mail by clicking [here](mailto:feedback@empirefinancialresearch.com?subject=Feedback%20for%20Berna). "I have enjoyed reading your essays on the Empire Financial Daily for some time. In fact, I first heard of NFTs through one of those essays, I'd guess a year or so ago. It was so well written that I thought it must have been a parody. I'm an old-timer, so I still can't believe that people pay real money for this stuff (nonstuff?). "[I] have enjoyed your commentary so much that I have become a paying customer for your Empire Market Insider and have followed several of its insightful recommendations. However, I was disappointed that the issue that I received today did not specify the ESG recommendations that I know you have made and the general thesis, which seems compelling. I would have thought that, as a paying customer, I would be entitled to all your best thoughts." – Peter F. Berna comment: Peter, thanks for your kind words and being a subscriber to Empire Market Insider. You should be able to access the ESG report on the website. You can find it by clicking [here](. "This and many other discussions about the need for nuclear energy skip the serious problem of nuclear waste. I live in San Diego. The decommissioned San Onofre nuclear power plant sits right on the beach in San Clemente near us. The nuclear waste sits on the beach as well, waiting for a disastrous event to happen with a nuclear waste spill, a threat to a huge area population. Nevada agreed to take the waste but then backed down and left it sitting there. And the threat continues. Until we have a way to manage nuclear waste it remains a deterrent to nuclear energy use." – Michael L. "Thank you for sharing your research, analysis, and insights with us. I agree nuclear should be part of the 'cleaner energy' equation. I am firstly most concerned that Iran and North Korea not develop nuclear capabilities and whether investing in URA might indirectly help these malevolent countries? Secondly, I too am a Gen Xer and am scared that human error with nuclear has the potential for horrific consequences. While we must continue to invest in cleaner technologies, we also are best off maintaining extracting oil in the U.S. and Canada. Thanks again!" – Andrea L. "Berna, you might want to look at a company with the ticker symbol UUUU. Yep. It's a uranium miner that has a lot of uranium stockpiled, so if the price goes up, so should their stock. They are also involved in the extraction and processing of some rare earth and metal compounds that are a byproduct of uranium mining. "Keep up the good work!" – Dave P. Berna comment: Dave, thanks for the tip. I will check it out! Regards, Berna Barshay January 27, 2022 If someone forwarded you this e-mail and you would like to be added to my e-mail list to receive e-mails like this every weekday, simply [sign up here](. © 2022 Empire Financial Research. All rights reserved. Any reproduction, copying, or redistribution, in whole or in part, is prohibited without written permission from Empire Financial Research, 601 Lexington Ave., 20th Floor, New York, NY 10022 [www.empirefinancialresearch.com.]( You received this e-mail because you are subscribed to Empire Financial Daily. 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