Weekly reading – 7th August 2021

What I wrote last week

I wrote about why credit card issuers should try to get into consumer digital wallets

Business

Pearson bets on direct-to-student subscription shift. I am never a fan of publishers like Pearson for a simple reason: books are murderously expensive in the U.S. In addition to the sky-high tuition fees, students have to pay easily a few hundred dollars or a thousand dollars a semester for books alone. There are ways to go around that challenge, but sometimes these guys work with professors and students are left with no choice, but to make a big splash on books. Pearson seems to be aware of the unsustainability of their current model. By going straight to students, they can establish a direct relationship and avoid relying too much on educational institutions. $15/month means students can pay $75/semester for access to all the books required. However, there are other publishers on the market. If students must get books from multiple sources, it can dilute the appeal of this new service from Pearson. I really look forward to seeing how this strategic move will pan out in the future.

Apple Is Now an Antifragile Company. A nice article on how shrewd Apple is when it comes to securing its chip supply while other struggle. I feel that not enough has been said about what a great job Apple’s management team has been doing. It takes a great deal of discipline to use billions of cash wisely quarter after quarter. The executives also have the foresight to develop their own chip M1 to keep more control of their fate and avoid being in the mercy of Intel. Additionally, the decision to make forward orders in bulk in advance has proven to superior. While others cite the struggle with chip supply as the reason for their relative subdued performance, Apple still posted strong results.

Music labels split over Spotify’s push to promote songs for lower royalties. I haven’t used the Discovery Mode yet, so I don’t know what it is like. I did have a less than stellar experience with the Spotify app; which I haven’t used for a long time. It’s not user-friendly at all. And if what is reported in the article is true, as a shareholder, I’ll be very disappointed. Sacrificing the user experience and the integrity of an algorithm like that over lower royalties and higher margin isn’t in the long-term best interest for the company, in my view.

Disney, WarnerMedia and NBCUniversal wrestle with balancing the value of cable networks and streaming services. I don’t think streaming is the best place for a newcomer with one cash cow to enter. The likes of Apple can arrive late at the part and compete because they have enormous resources and streaming isn’t their top 5 or 7 revenue stream.

The Verge interview with YouTube Chief Product Officer.

5 charts show Amazon’s growing logistics network as it puts inventory closer to consumers. Some great data and information, but I don’t think Amazon is playing the same game as Walmart. Operating huge stores with a lot of SKUs is not Amazon’s strength, at least compared to Walmart, for now. I don’t think it’s wise for Amazon to get into that arena. What I think Amazon is plowing money into is the last mile delivery. If groceries are what needs delivering, they are building out Amazon Go shops and can leverage Whole Foods footprint. However, if we are talking about non-grocery items, then Amazon is taking a very different approach to Walmart and staying at what Amazon has been great at: an online store with great customer services and unrivaled last-mile delivery network

What I found interesting

U.S. generates more plastic trash than any other nation. The amount of plastic bags in supermarkets in the U.S such as Target or Walmart staggered me. I don’t understand why they don’t implement policies that encourage shoppers to bring their own bags or boxes like Aldi does. At Aldi, you have to bring your own bag unless you are willing to pay for one every single time. I don’t think shoppers are bothered by that. If the likes of Target and Walmart can join the fight against unnecessary use of plastic, it’ll be a huge step forward given the reach and size of these retailers.

London’s Crossrail Is a $21 Billion Test of Virtual Modeling. Technology is mind-blowing. So is human imagination

Stats that may interest you

Luggage sales are up more than 460% year over year (Q1 2021)  on Amazon while swimwear sales have more than doubled year over year as of March and April 2021

From 2006 to 2021 per-capita volume consumption of juice and nectars in the U.S. declined 36%

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.

Notable notes from Disney’s earning call

Today, Disney released their 2019 Q3 result. Below are a few points that stood out for me

  • Hulu got 28 million paid subscribers while the figure for ESPN+ stood at 2.4 million
  • The integration of 21 Century Fox had negative impact on Disney’s earning, including the subpar performance of movies such as Dark Phoenix
  • Direct-to-Consumer & International segment expected to make $900 million loss in the next quarter, due to investment in the launch of Disney + and support for Hulu, ESPN+
  • Fantastic results for the studio as per Bob Iger

The studio has generated $8 billion in global Box Office in 2019, a new industry record. And we still have five months left in the calendar year with movies like Maleficent: Mistress of Evil, Frozen 2 and Star Wars: The Rise of Skywalker still to come. So far this year, we’ve released 5 of the top 6 movies including four that have generated more than $1 billion in global Box Office. Avengers: Endgame is now the highest grossing film in history with almost $2.8 billion worldwide. Captain Marvel, Aladdin and The Lion King have each surpassed $1 billion. And with more than $960 million in Box Office to date, Toy Story 4 will likely cross that threshold in the coming weeks. And all of these movies will be on Disney+ in the first year of launch.

SeekingAlpha
  • The leadership behind the studio will manage the film strategy for 21 CF as well
  • Deadpool, Fantastic 4 and X-Men will be part of Marvel Studios
  • Come this November, users can have access to Disney+, Hulu (ads-supported) and ESPN+ as a bundle for $12.99 a month, well below the total sum of all threes, if subscribed separately
  • “Hotstar had more than 300 million average monthly users, served an unprecedented 100 million daily users and delivered a high-quality streaming experience to 25.3 million simultaneous users, which is a new world record”
  • Disney is discussing deals with Apple, Amazon and Google as distribution partners, deals that are expected to close
  • Focus on marketing for Disney+, per Bob Iger

Disney+ marketing is going to start to hit in later this month, later in August. We’re actually going to allow members of D23 to be the first to subscribe. I’m actually going through a comprehensive marketing plan with the team next week. Comprehensive probably is an understatement. It is going to be treated as the most important product that the company has launched in, I don’t know, certainly during my tenure in the job, which is quite a long time. And you will see marketing both in traditional and nontraditional directions basically digital and analog also significant amount of support within the company on basically company platforms. And then of course all of the touch points that the company has, whether it’s people staying in our hotels, people that have our co-branded credit card, people who are members of D23, annual passholders, I could go on and on. But the opportunities are tremendous to market this. And I feel good about some of the creative that I’ve already seen. But you won’t start to see it until later this month.

SeekingAlpha

Quick Thoughts

I cannot wait to see the battle of the streamers and how well Disney+ will fare. As a student of business, I am fascinated to see the strategies and execution of Disney+ vs Netflix. Netflix has a huge subscriber base as advantage over Disney+, in addition to a household name (ever heard of “Netflix and chill”?) and some great original content. But Disney has its own strengths as well, including marketing expertise, household name, a great content library and additional revenue streams.

I am thrilled to see how fast Disney+ will be able to sign up folks. The emphasis on marketing, the aggressive pricing of the streaming service, the bundle and the focus on exclusive content in spite of loss from licensed deals show that Disney is dead serious. It will be interesting to see how viewers will react and whether there will be some market share loss by Netflix at the hands of Disney+ and other upcoming streamers.

I honestly don’t know how it will go. As a fan and a consumer, I cannot wait to see.

Disclaimer: I own Disney stocks in my portfolio.