MorningWord 7/29/16: Your Netflix Queue

by Dan July 29, 2016 9:49 am • Commentary

After this post I am going to sign off for the rest of the day and I won’t be doing TV tonight. I am going upstate to pick up my girls from camp, and then make my way east to Maine with my family.  No one ever told me the dog days of Summer involved 12 hours of driving in a 24 hour period!  Have a great final weekend in July.


In the last two days, better than expected earnings reports from Facebook (FB), Amazon (AMZN) and Alphabet (GOOGL) have propelled the stocks to new all time highs. These three stocks equal almost $1.3 trillion in market cap, or a quarter of the value of the Nasdaq 100.  That’s truly astounding but when you consider the massive revenue, and the pace at which they just grew in Q2 (AMZN $30.4 billion grew at 31% yoy, FB $6.4 billion grew at 59% yoy and GOOGL $17.4 billion grew at 22% yoy) maybe their valuations make some sort of sense in an environment where tech behemoths like Apple (AAPL), Cisco (CSCO), IBM, Intel (INTC) & Microsoft (MSFT) would be thrilled to get back to high single digit topline growth.

On AMZN & FB ill just do this¯\_(ツ)_/¯, on GOOGL I’ll just add that a company as mature as they are, to be growing sales at 22% to the tune in which they do, at the profitability level in which they achieve… is astounding. I won’t say another skeptical thing until they give reason to do so.

So what’s up with the N in FANG?  Netflix (NFLX) is down 20% on the year, and down 33% from its all time highs made in early December. By all accounts NFLX CEO Reed Hastings is playing off of the playbook that AMZN CEO Jeff Bezos wrote in the late 1990s and aughts. That’s the same playbook the GOOGL guys were known to dream of and that Zuckerberg has riffed on at times. For the most part none of these visionary CEOs have given a rats ass about what Wall Street analysts, investors or pundits thought of near term as the their long term vision is all that mattered. Maybe NFLX is in one of those funks that all these companies face at some point. Don’t forget that at one point in early 2016 AMZN was down 32% from its 52 week highs.

Since closing 13% lower the day after its disappointing Q2 results / Q3 guidance on July 18th, NFLX shares caught a bid earlier this week it was disclosed that the company’s lead director on the board bought 600,000 shares in the open market the previous week between $85.76 to $87.60, bringing his firm’s holding to 6 million shares:

Which brings me to some unusual options activity in the stock yesterday. I’ll offer my usual disclaimer, without intimate knowledge of the intent of an options trade seen in the market, it’s useless to draw too many definitive conclusions as you have no idea if the position is a volatility trade, against current positioning, a hedge etc. But in the case of the trade I’m going to detail (that traded yesterday), it is fairly clear that it is a new bullish trade. I’m able to glean this from the trade structure. Again I have no idea whether the initiator is the worst trader/investor on the planet, or if it’s Warren Buffet himself. But the trade structure is worth detailing either way.

Shortly before the close, when NFLX was trading $91.60 a trader sold to open 5,000 Nov 65 puts at 81 cents and bought to open 5,000 of the Nov 105 / 115 call spreads for $1.86, the net debit for the call spread risk reversal is $1.05, or $525,000 in premium. Between 65 and and 105 on Nov expiration the trader would lose the 81 cents in premium paid. Between 105.81 and 115 the trader can make up to $9.19, or about $4.6 million, with the maximum gain above $115.  The worst case scenario is that the stock is below 65, down almost 30% and the trader would be put 500,000 shares of stock (plus the loss of the 81 cents in premium, or $525,000).  This is a reasonably bullish trade as the probability of the worst case is far less than the probability that the 105 call strike will be in the money on Nov expiration (about 8% chance vs 16% respectively) with the highest probability that the trader will lose the $525,000. 

This is the sort of trade I might do to lever up an existing long, looking out to Q3 earnings in Oct to serve as a positive catalyst for the shares into what should be a seasonally strong Q4.

I’ll add one more point here. NFLX is a premium brand, with broad reach in a segment that the company basically invented, and in doing so, turned the media industry upside down.  The company is now dealing with speedbumps in their international expansion and pricing pressure in mature markets as large competition from the likes of Apple, Amazon, Alphabet & Time Warner have them in their sights.

While we have seen a massive binge in M&A in the semiconductor space in the last year (read here from earlier in the week), some deals in the Cloud (Oracle paid $9 billion for Netsuite yesterday), they all seem to be logical from a strategic standpoint. But before this lil’ bull market ends, I suspect we will see at least one stupid deal that no one thought would ever happen, and that could be how the N in FANG gets back to its all time high.

If MSFT is willing to pay $27 billion for LinkedIn (LKND) because they think they are gonna get massive synergies from their customer data despite running the company as a standalone (I’m VERY skeptical on that), then why the heck wouldn’t Apple, Amazon or Google be willing to pay a 50% premium to NFLX’s $40 billion market cap? The idea here is that one of the aforementioned would immediately leapfrog the others, gain a valuable brand and plug in their 47 million paid U.S. subscribers and 36 million internationally to their existing ecosystems in an effort to create a stronger network effect.  With the cash balances where they are with those three ($231 billion, $17 billion & $84 billion respectively), rates where they are, and in the case of AMZN & GOOGL their stocks where they are, the combination of cash, debt and stock as a currency seems to make all the sense in the world for a risky investment, especially if you possess a 50 year time horizon as Cook, Bezos & the Google guys claim to eye.

So this is just pie in the sky sort of stuff, but before its all said and done I suspect we will see at least one blockbuster deal in tech, and NFLX will likely be on the short list. It is that unique of property.