Weekly reading – 24th April 2021

What I wrote last week

On Apple’s new product: AirTag

Apple TV+, Netflix and the battle between Walmart and Amazon

Business

Google used ‘double-Irish’ to shift $75.4bn in profits out of Ireland. It’s good to know that 2020 was the last year that the “double Irish” loophole could still be exploited. I am curious to see the impact that the phase-out has on US corporations.

WSJ’s short profile of Korea’s “King of Ramen”

AirTag location trackers are smart, capable and very Apple

The Future of Apple Podcasts

Etsy SEO: How to Optimize Your Shop & Listings for Search

How Netflix and social media helped F1 buck a global sports sponsorship slump. F1 is an extraordinary sport and deserves to be the pinnacle of motorsports around the world. If you look below this entry, you’ll see a graphic showing how F1 cars can go into corners at a speed that we travel on a highway. On the straights, F1 cars can hit 360kmh. The technology that goes into building these cars and the skills that go into driving them are the best in the world. Yet, I still feel that F1 isn’t as popular as it should be. “Drive to Survive” and the resilience shown during 2020 really helped the sport become better known

What I find interesting

Typography at U7 station in Berlin

You can pay at Whole Foods Market with your palm now. While it is incredibly cool and convenient, I don’t think I will jump at the chance to use it soon. Amazon isn’t really known for their privacy practices. I am not too willing to give away my biometrics to them yet.

F1 cars can slow down by 144kmh in 1 or 2 seconds and carry over 150kmh into corners. Just think about that for a second. These cars drive into cars at the speed that is often the top you can reach on the highway

Source: F1

Stats that may interest you

Morning Brew has 3 million subscribers. It’s amazing what you can do with great writing skills and consistency

iPhone 12 models accounted for 61% of US iPhone sales in fiscal Q2 2021

Apple TV+ has the highest ratings among streamers. Walmart vs Amazon. Netflix recorded slower growth but saw 2x growth in FCF

Apple TV+ has the highest IMDB ratings for content

According to a new study, content on Apple TV+, Apple’s exclusive streaming service, receives the highest average ratings on IMDB. There are a couple of caveats here: 1/ this is on average. One size cannot fit all in this streaming area. The study reveals that Apple TV+’s content ranks pretty low in some genres. Hence, if you are a connoisseur of Crime or Fantasy content, the streamer may not be your cup of tea. 2/ Apple TV+ has a significantly smaller library than other streams. As a result, the smaller sample may favor Apple’s streamer.

Focusing on content quality is a smart move from Apple. The likes of Disney+ or Netflix already have a lot of titles to offer viewers. It would take Apple either a long time or plenty off money to acquire the rights to stream titles from other producers. Even then, they still likely wouldn’t come out on top because the other heavyweights aren’t standing still to lose their market share. Plus, I don’t imagine Apple TV+ is a profit center for Apple. At $5/month and restricted to Apple devices or Roku, I don’t think Apple TV+ reaches the scale that enables them to raise prices yet. It is an auxiliary service that makes their bundle Apple One or their devices more attractive and sticky to consumers. Services like Apple Care or iCloud, and their hardware are the drivers of margin and profit. It doesn’t make sense for Apple to try to compete with Netflix on the number of titles while diluting investments on quality. The prospect of Apple TV+, with its much smaller subscriber base, beating Netflix on their own game doesn’t seem likely. Plus, focusing more on quality resonates more with the Apple brand.

Walmart vs Amazon

The battle of these two retail titans is exciting to watch. While Walmart has been trying to improve its 3rd party marketplace & ads platform and grow its fintech segment, Amazon has also had some developments on its own:

Walmart has the advantage of low-cost grocery, a category that is near and dear to every shopper, and a network of stores scattered around the country that can act as their fulfillment centers in addition to the actual dedicated ones. On the other hand, Amazon has a more mature online presence, 3rd party marketplace and ads business. It also has 200 million loyal and, in my opinion, profitable customers in their Prime program. For the past months, each company has tried to close the gap to the other. Walmart launched a Walmart+ service, their answer to Prime, while ramping up their marketplace, including the partnership with Shopify, and ads business. Meanwhile, Amazonzz has invested heavily in last-mile delivery and cashierless stores. Even though it’s tough to match the scale of Walmart in groceries, having smaller stores and no headcount expenses will definitely help Amazon drive down the prices.

Which retailer will come out on top remains to be seen. It’s exhilarating, though, to see each iconic firm expand its capabilities and go out of its comfort zone to stay competitive. If I were a business or strategy professor, this would be one of the cases I bring to classes.

Netflix recorded slower growth but saw 2x growth in FCF

The results of Netflix’s first quarter FY2021 were out today. Revenue stood at $7.2 billion, a 18% YoY growth, while operating income was almost $1.9 billion, up 44% YoY. The quarter closed with almost 208 million paid subscriptions, including 4 million in net additions compared to almost 16 million subscribers in net add a year ago. The company attributed the slow growth in subscribers to the pandemic and a weak slate of titles. While Netflix is still confident in the 2nd half of the fiscal year, it does forecast a relatively flat weekly global net adds till the end of the 2nd quarter.

Netflix's flat forecast in net subscriber adds till Q2 FY2021
Source: Netflix

While a slower subscriber growth isn’t good news to Netflix investors, it doesn’t tell the whole story. First of all, they may actually be right that the pandemic and having no hits this quarter had adverse effects. Second of all, Netflix raised their subscription prices a few months ago; which may also be another contributing factor, especially given the intense competition from other streaming services. HBO premiered two blockbusters: Godzilla vs Kong and The Snyder Cut. Disney Plus had their exclusive Wanda Vision and The Falcon & The Winter Soldier, among other titles.

Additionally and very importantly, Netflix increased its free cash flow by 200%, despite a stunted subscriber growth. The company’s free cash flow in Q1 2021 was $692 million, up from $162 from the same quarter a year ago. In the shareholder letter, Netflix was confident that they would be FCF neutral for FY2021 and that they had no plan to raise debt in the near future. More excitingly, they are beginning to buy back shares this quarter. For the Netflix bulls out there, it’s great news. The company spends $20 billion a year on content, yet it is on track to become FCF positive; which almost no other streamer can replicate. That’s the beauty of operating at the scale that Netflix does. Their content investment is a fixed cost. The more paid subscribers there are, the lower the unit cost for each subscriber will be and the higher margin Netflix can extract. However, for other streamers, they have to invest a lot in content to grow their subscriber base. Since their current pool isn’t big enough, they are likely operating in the red with negative cash flow like Netflix used to. The question then becomes: how long can those streamers sustain that loss while trying to match those billions that Netflix pours in content annually?

Yes, seeing their growth stunted this quarter isn’t great, but it’s just one piece of the puzzle. The FCF piece that Netflix announced today is, in my opinion, equally important. One quick look at notable news outlets that covered Netflix earnings showed one common theme: Netflix’s growth. I mean, it’s not wrong, but I don’t think their headlines tell the whole story

Coverage of Netflix's Q1 FY2021 earnings without mentioning the cash flow story

Weekly readings – 15th August 2020

What I wrote last week

I wrote a bit about Epic Games vs Apple, Goldman Sachs’ inroad further into consumer credit card world and the potential departure from California of the likes of Uber & Lyft

A historic day for America when Kamala Harris was named as Biden’s Vice President Candidate

My thought on Disney’s latest quarter

Business

Horace Dediu wrote a blog post answering some questions on Apple’s cash strategy

A long and informative deep dive into TikTok and what makes it great

Another deep dive by Turner Novak on Pinduoduo

Nick Sleep on Costco

Meet the Woman Who Got Joe Rogan and Michelle Obama to Spotify

Netflix Business Model & Economics 

A thread on why Avalara has real competitive advantages

Technology

Here’s why Apple believes it’s an AI leader—and why it says critics have it all wrong

How the government’s new real-time payments system could transform commerce

Apple wins a Patent for a Possible Dual Display MacBook Supporting a Virtual Keyboard & more

A potentially life-changing technology for visually-impaired folks

What’s going on with Apple Maps

What I find interesting

An inside look at a data analytics firm that Mike Bloomberg is using to help Democrats

The 19th-century entrepreneur who pioneered modern ice cream

A very long and interesting post on the bombing of Hiroshima and what was happening at the time based on recollections of a few survivors

Giant American Cars Don’t Belong on the Streets of the Future

How Taiwan’s Unlikely Digital Minister Hacked the Pandemic

Weekly readings – 7th August 2020

What I wrote last week

Uber’s latest quarter

Apple’s acquisition of this promising fintech startup from Canada

Business

Inside Netflix’s Quest to Become a Global TV Giant

US citizens increasingly moved to Canada through its Express Entry program

Content creators on YouTube that no longer rely on advertising dollars on the platform grew 40% between Jan and May 2020

Why Microsoft wants Tiktok

A sensible piece on Amazon, its private label and the antitrust issue that it has to deal with

Eugene Wei’s latest essay is on TikTok and it’s good

ARK’s latest white paper on SaaS

How Tim Cook has molded Apple into his own version, not Steve Jobs’

Technology

Apple secured a new patent that could equip Apple Watch with odor sensor technology

What’s the Big Deal About Revit? Understanding the Role of Autodesk Revit in Architecture, Engineering, and Construction

Other stuff that I think is interesting

Inside look at CloudKitchens

Bill Gates’ conversation on Covid-19

Drive To Survive Season 2 is a surprisingly good series

I am an F1 fanatic. I have been following the sport for more than 10 years. I also wrote about it multiple times on this blog. Personally, Formula 1 appeals to me with its unpredictability and its “nerdiness”. A lot of elements go into a race weekend, including top class engineering, data analytics that powers strategy and a split-second decision to deal with the changing elements in a race. Despite having races in 21 countries in the world, I feel that somehow it’s still a foreign sport to many. Not a whole lot of folks that I know follow the sport. Those who do developed a strong love for it like I do.

That’s why I was pretty excited about Drive To Survive Series – Season 2 by Netflix. To be honest, I didn’t watch the first season because my favorite team, Ferrari, and its rival- Mercedes, weren’t featured. The 2nd season showed that the streamer was given an unprecedented access to the paddock and teams. Cameramen followed drivers and team principals to their personal homes. Behind the scene footage where access was normally restricted was available. Folks who were interviewed gave answers that would have made significant headlines had they been published at the time. Watching it made me miss F1 even more than I do now. Like all other sports, F1 has been put on hold because of COVID-19

I do think that the series will bolster the popularity of F1 globally. I have seen positive reviews on Twitter regarding the 2nd season. If you run out of favorite shows to watch, I highly recommend it.

Netflix’s change in view accounting and a misleading use of Google Trends

This week, Netflix dropped its latest earnings report. There are a lot of positive announcements from Netflix and kudos to them for weathering the rising competition from a plethora of streamers, so far. Nonetheless, there are a couple of notable points that I am either intrigued by or in disagreement with.

How a view is counted

Netflix used to register a view whenever a user passed a 70% of a show or a movie. Recently, the company changed that policy. According to the latest earnings report, whenever a viewer reaches a two-minute mark, it counts a view.

Source: Netflix

Netflix communicated the change in a tricky and inconspicuous manner. The explanation on the two-minute mark only came in the footer; which certainly isn’t where readers’ attention focuses on.

Source: Netflix

As you can see in the last sentence in the screenshot above, the change in the view accounting usually results in an increase in view because of obvious reasons. I don’t believe two minutes is enough to determine the intention of the audience. It is not uncommon that viewers watch 20 minutes of a show or a movie before leaving. If Netflix thinks that 70% is too high a standard, 40% or 50% would make more sense than the new implemented policy.

Using Google Trends to compare The Witcher with Mandalorian

In the Competition section of the report, Netflix dropped a Google Trends screenshot that showed interest in its currently flagship show The Witcher, Mandalorian, Jack Ryan and The Morning Show in the last 90 days worldwide

Source: Netflix

First of all, I am not sure this is an apple-to-apple comparison due to the difference in availability. Disney Plus is only available in US, CA, Australia, New Zealand and Netherlands. Even though Prime Video is supposedly accessible worldwide, while I was in Vietnam, I couldn’t watch many shows on the platform despite my membership.

Netflix said that even if Disney+ were global, the results wouldn’t be much different, citing the following result on Google Trends

I wouldn’t make that claim with such a degree of certainty. Netherlands is just a small country in Europe with about 17 millions in population. The viewership and interest in that country doesn’t equal to those worldwide.

Furthermore, the shakiness of the comparison can also come from the selection of keywords. Since The Witcher or Witcher is the name of a video game released in 2017, neither of the two keywords isn’t exclusive to the show on Netflix. Unfortunately, Google Trends doesn’t offer a feature that can clearly separate the show and the video game. The best that we can do is to filter the results by categories. I tested it out by comparing the keywords: Witcher, The Witcher,

As the screenshot shows, there is a big different between “Witcher” and “The Witcher”. The gap is even starker when “Netflix” is added to the search terms. If we set “Art and Entertainment” as the category, the picture will look a bit different

The Witcher/Witcher keywords had a spike on 21st December 2019, one day after the launch of the Netflix show while Mandalorian hit its peak on 28th December 2019, one day after the season finale. The difference between the yellow line and the red line is closer when we look at “Art & Entertainment” alone than when we look at “All categories” which may likely include the effect from The Witcher video game.

Now, the result above still doesn’t offer the full picture thanks to the difference in geographical availability, Let’s look at the US, two markets where every show is available

If we look at the United States alone for All Categories, it looks more favorable for Mandalorian. When “Art & Entertainment” is applied, it fares even better for Mandalorian

Here are the results for Canada

What about Australia?

My point is that there are several factors that affect how the search terms are presented on Google Trends and how results should be interpreted. I don’t have an idea on how the competing shows actually fare. I do believe that the way Netflix presented the information and data in its report is misleading at best.

Disclosure: I have Disney and Apple stocks in my portfolio.

Mixed Feelings from Netflix’s Earnings Report

Netflix released its earnings yesterday. There are causes for optimism and concern from what I have seen.

Important metrics improved YoY significantly

This quarter, Netflix added 517,000 domestic paid subscribers and more than 6.2 million international paid members, bringing the total subscriber count domestically and internationally to more than 60.6 million and 97.7 million approximately.

Contribution margin for domestic and international streaming is 41% and 20% respectively, resulting in the margin for streaming to be around 30%. Contribution margin of Domestic DVD is around 61%. Contribution margin represents what is left of revenue after all the variable costs to pay for fixed costs and to generate profit.

On a year over year basis, revenue, operating income and paid memberships saw remarkable growth for a company this size

Cause for concerns

Even though domestic paid memberships increased, Netflix missed its own expectation by almost 300,000, making it the second consecutive quarter that it did so. The company blamed the miss on the higher pricing elasticity than expected

That’s really on the back of the price increase. There is a little more sensitivity. We’re starting to see the – a little touch of that. What we have to do is just really focus on the service quality, make us must-have. I mean we’re incredibly low priced compared to cable. We’re winning more and more viewings. And we think we have a lot of room there.

But this year, that’s what’s hit us. And we’ll just stay focused on just providing amazing value to our members in the U.S. And I think that gives us a real shot at continuing to grow net — long-term net adds on an annual basis. But we’re going to be a little cautious on that guidance and feel our way through here.

CEO – Reed Hasting in Earnings Call (Per Seeking Alpha)

I saw a sentiment floating around on Twitter a while back that argued that Apple TV+ and Disney+ aren’t really competitors to Netflix. I mean, to some extent, they may differ a bit from Netflix, but if we want to talk about competing for viewers’ attention, time and disposable income, how can they not be? Sure, boats move different from trains, but if patrons can choose either to go from point A to point B, how can they not compete with each other? Now Reed Hasting admitted the challenge from other streamers, especially Disney+

From when we began in streaming, Hulu and YouTube and Amazon Prime back in 2007, 2008, we’re all in the market. All 4 of us have been competing heavily, including with linear TV for the last 12 years. So fundamentally, there’s not a big change here. It is interesting that we see both Apple and Disney launching basically in the same week after 12 years of not being in the market. And I was being a little playful with a whole new world in the sense of the drama of it coming. But fundamentally, it’s more of the same, and Disney is going to be a great competitor. Apple is just beginning, but they’ll probably have some great shows, too.

But again, all of us are competing with linear TV. We’re all relatively small to linear TV. So just like in the letter we put about the multiple cable networks over the last 30 years not really competing with each other fundamentally but competing with broadcast, I think it’s the same kind of dynamic here.

Source: Seeking Alpha

Chief Product Officer Gregory Peters made an important point below

I would say our job and then what we think our pricing for a long-term perspective is continue to take the revenue that we have that our subscribers give us every month, judiciously and smartly invest it into increasing variety and diversity of content where we really want to be best-in-class across every single genre.

And if we do that and we’re successful in making those investments smartly, we’ll be able to continue to deliver more value to our members. And that really will enable us to, from time to time, ask for more revenues so that we can continue that virtuous cycle going

Source: Seeking Alpha

Quite an important “if” condition there. In short, Netflix borrows capital to invest in content to the tune of billions of dollars every year and hopes that their subscriber base growth and revenue will keep enabling them to do so. In essence, every streamer will do that. Every single one of them needs to churn out quality content to convince viewers to choose their service. Failure to produce quality content to justify expensive investments will be costly for these streamers.

For Netflix, the stakes seem to higher. Other competitors have additional revenue streams apart from their streaming service. Netflix essentially relies on their subscription revenue. As this quarter shows, the price elasticity already has some negative effect, and it’s BEFORE other heavy-marketed competitors such as Apple TV+ and Disney+ debut in 2-4 weeks. The new challengers price their services at much lower points than Netflix. The room to increase price to recoup their investments faster is getting smaller. I do think a price hike will negatively affect Netflix.

Some may say: oh Amazon kept investing heavily in their early days as well and Netflix can be the same. They are not, as I wrote here. Their free cash flow continues to be in the red while Amazon was in the black for years.

The expensive bidding war for content may play into Netflix’s favor. Their huge subscriber base enables them to spread the cost much better than competitors, especially new ones that have to acquire subscribers from scratch. Hence, it can be argued that Netflix will be one of the only few standing after the dust settles. It does make sense to think about the streaming war’s future that way. As does it make sense to think that there is a possibility that the game Netflix is playing may not work out for them, given the intense competition, the decreased price inelasticity, the huge debt they have incurred and the continuous negative free cash flow.

I think that we will have more clues around the next earning call or two as we’ll see how Netflix will fare after the arrival of Apple TV+ and Disney+. Even then, we won’t know definitively who will win in the end. Fascinating times ahead.

Weekly readings – 5th October 2019

Grab Accounts for 73% of Ride-Share Trips in First Half of 2019 in Vietnam.

Retailer Adoption of Apple Pay Quickens. Since I was able to use Apple Pay on my phone, I have been using it as the first payment method, even in a city as small as Omaha. I have been a pretty happy user ever since.

Source: Loup Ventures

Comparison of smart digital assistants by Loup Ventures

Meet the Women Leading Netflix Into the Streaming Wars

The man who built his own Lamborghini

Dog-walking startup Wag raised $300 million to unleash growth. Then things got messy. SoftBank doesn’t seem to be the Midas that some hyped it to be with its massive checkbook, does it?

Latest memo from Howard Marks: On the Other Hand

Researchers Discover the Tallest Known Tree in the Amazon

Measuring Apple’s Content Distribution Arm

WeWork Used These Documents To Convince Investors It’s Worth Billions. A long but good article on the accounting jujitsu that WeWork employed

Jiro Ono Documentary

I came across Jiro Ono when I was reading the latest book by Bob Iger, which I wrote about here. I decided to restart my Netflix membership to watch this and it’s worth it.

Jiro Ono lived on his own at the age of 9 without his parents. For almost 75 years, he has been making sushi and doesn’t show any signs of abating. He is still working day and night; and he shows energy of a guy much younger than his age. His dedication to make the perfect sushi and improve every day is so inspiring. Watching him find the perfect suppliers for fish, wasabi and rice as well as prioritize simplicity in his sushi making is exciting.

He is the oldest 3-star Michelin chef in the world and Michelin said that 3 star is the only rating adequate to Jiro’s restaurant. If you are looking for something great to watch on Netflix, I highly recommend it

Are money-losing companies similar to Amazon?

A bullish argument for money-losing companies (companies that have negative operating income) I have seen so far is that they are following the footsteps of Amazon in the early 2000s before the juggernaut became what it is today. Set aside the differences in business environments, the nature of industries and technological advances, there is one important caveat; even though Amazon reported negative net income for a few years before turning profitable, it had POSITIVE free cash flow during that time.

Per corporatefinanceinstitute, Free Cash Flow (FCF) “represents the amount of cash generated by a business, after accounting for reinvestment in non-current capital assets by the company”. It’s equal to, simply speaking, cash generated from operations minus Capital Expenditure (CAPEX). It is a metric to show investors how efficient a company is generating cash and whether the company at hand has enough to pay investors after operational needs and capital expenditures.

This is what Amazon’s annual and quarterly free cash flow looks like over the years. Data is from macrotrends:

Over the years, free cash flow noticeably grew bigger for Amazon, but it was positive even before the introduction of AWS in 2006, which has been the margin maker for Amazon recently. Hence, if a company has negative operating income and still makes capital expenditures to grow, they are NOT similar to Amazon.

A particularly intriguing case is Netflix. The streaming king debuted its streaming service in 2007 and has grown to become the de facto leader in the market. It has had positive operating income, but increasingly invested a massive amount of money in original content, much more than the cash it generates from operations every year.

Since Q3 2014, Netflix hasn’t had a single quarter with positive FCF. The challenge Netflix is facing compared to its competitors is that Netflix has only one source of revenue. Disney, Amazon and Apple, to name just three competitors, have different sources of income. In the case of Amazon and Apple, their streaming services can be argued to be add-on services that function to lock in customers. It is true that given its almost 150 million subscribers, Netflix can spread its content costs across more subscribers than its competitors. Nonetheless, it has to keep investing every year in original content to appeal to consumers. If there is no change in how Netflix can generate revenue besides subscription, I struggle to see how its FCF outlook will differ. Hence, Netflix’s story is NOT similar to Amazon’s in the early 2000s.