Why Ackman Should've Shorted Netflix Instead

·4 min read

Netflix NFLX was one of the big winners of the stay-at-home trend when the pandemic initially hit, but also faced increased competition from companies such as Apple, Amazon and Disney. It’s been quite a rocky start to 2022 for the once DVD-rental company. At the beginning of the year, the streaming giant shocked investors with management guidance that included just 2.5 million subscriber additions for the first quarter of 2022 – far fewer than the consensus expectation at the time of 6.9 million. Netflix shares tanked more than 20% immediately following the news.

The newly discounted price attracted the likes of major investors including Bill Ackman (head of hedge fund Pershing Square Capital Management) who purchased 3.1 million NFLX shares in January, making his fund a top-20 shareholder. While most investors bailed following the price plunge, Ackman bought shares as he found most of the Street to be shortsighted. Ackman is known as an activist investor who has a history of altering the strategic direction of companies and implementing changes to their boards, but this purchase was made for different reasons.

According to Ackman, the $1 billion Netflix purchase offered “an attractive valuation and compelling risk/reward” while stating that Pershing Square was “all in on streaming”. If he loved it at ~$380/share, how does he feel about Netflix at $225?

Ackman remains attracted to Netflix’s subscription business model – one that generates a recurring revenue stream and typically provides visible and predictable insight into the company’s sales trends. He’s also a fan of Netflix’s top management team. Ackman still sees huge potential in terms of future revenue growth, particularly in international markets such as India. And according to management, NFLX is about to start producing positive free cash flow, introducing the potential for share buybacks in the future.

Yet in more mature markets such as the U.S. and Canada, Netflix is relying on pricing power to register progress. The streaming giant has implemented a series of price hikes to counteract the slowing growth. Yesterday after the bell brought Netflix’s first-quarter results for the year, which showed the company lost 200,000 subscribers – its first subscriber loss in over a decade. Analysts were expecting a net gain of 2.5 million, which would have still been down 74% from pre-pandemic levels.

Even worse, the company’s guidance is what has led to a -35% decline today, as Netflix stated next quarter will bring another drop of 2 million subscribers. Despite the Q1 subscriber loss, NFLX reported 10% growth in revenue relative to the same quarter in 2021. But that growth rate has substantially slowed in recent years, and it is this slowing growth that the market is now pricing in.

NFLX is a Zacks Rank #4 (Sell) stock and has missed earnings estimates in five out of the past nine quarters. The stock is part of the Zacks Broadcast Radio and Television industry, which currently ranks in the bottom 35% out of approximately 250 industries. And our Zacks Style Scores depict a weakening outlook for Netflix, as the Value, Growth, and Momentum categories are each ranked a second-worst possible grade of ‘D’.

Netflix has witnessed a batch of declining earnings estimates as of late, with analysts dropping their full-year EPS estimates by -0.18% in the past 60 days. The Zacks Consensus Estimate now stands at $10.86, translating to a -3.38% earnings regression relative to 2021. This number will likely be reduced further now that the company has forecasted the Q2 subscriber loss, which will likely further impact the price of NFLX shares. The stock has fallen -63% this year alone.

Netflix, Inc. Price and EPS Surprise

Netflix, Inc. Price and EPS Surprise
Netflix, Inc. Price and EPS Surprise

No matter how you slice it, NFLX is facing some serious headwinds. From stiff competition and slowing subscriber growth to the Russia-Ukraine war and unfavorable foreign exchange losses, the days of investors paying a high multiple for this streaming giant are over. It might even be time for Netflix to be removed from the ‘FAANG’ group. Today’s version of the ‘FAANG’ stocks are relatively unknown just like Netflix was 20 years ago. Who will the next leaders be?

Ackman recently stated his fund was done with major short selling, but it looks like he would’ve been better off sticking with that strategy and adding Netflix to the mix.

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