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P | Thoughts into the Print (2Q16)

Takeaway: We expect a small beat/soft raise, but the trajectory of P's underlying drivers/longer-term story may matter more than the actual print.

KEY POINTS 

  1. THESIS REFRESH: We covered our P short back in January following heightened bearish sell-side sentiment off the Web IV announcement.  P is now on our Long Bench; we believe it has more upside than downside from here since it diversifying away from the ad-supported model.  But we're concerned about execution; particularly on interactive.  P currently has limited if any leverage in negotiations, especially since it has publicly set expectations around the timing of its interactive rollout.  Our other concern is on the core business, specifically around a slowdown in Local Advertising, especially if it is coupled with delays in striking interactive deals.  Collectively that could push the speculative bulls out of the name.  Regarding the 2Q print, we expect a small top-line beat with the mid-point of the 3Q guide coming in below consensus and full-year guidance raised inline with the 2Q beat.  But we suspect the print will matter less than its underlying drivers (e.g. Local Ad Revenue growth) and the trajectory of P's longer-term story; collectively what we're focusing on below.  
  2. LOCAL CONCERNS: P's Local Revenue growth reaccelerated last quarter (42% vs. 34% in 4Q15), a big positive at face value since it appears to be driven by a surge salesforce productivity (1Q local reps up 12% y/y vs. 39% in 4Q15).  But the more realistic way to assess productivity is on a lag since it’s not likely that P’s new reps are producing at full capacity when being hired intra-quarter.  On that basis, P only saw marginal improvement in productivity in 1Q, extending a stretch of waning productivity.  Mgmt has curbed the rate of Local Rep hiring recently, which is a concern since headcount has historically been its largest source of Local Revenue growth.  Looking out to 2H16 Ad revenue estimates, we see 3Q16 as stretch, and have to take a big leap of faith on productivity gains to get to 4Q16 estimates, especially since National salesforce productivity has been largely declining on a y/y basis.  
  3. INTERACTIVE TIMING? P expects to sign direct licenses with each of the major labels by 4Q16 and go to market in 1Q17.  However, we can't assume that timing will go exactly to plan.  From the perspective of the labels, we have to wonder if they are in any rush to get a deal done with P that isn't decidedly in their best interest.  There are at least 2-3 established interactive providers today; letting P in may not accomplish much more than adding a new interactive vendor to sell what is currently a largely commoditized product.  In turn, that could just incite more pricing pressure within the industry, which would directly impact the labels' interactive revenue, without any guarantee of a lift in interactive subscribers.  We get that P has 80M current users that it could target, but they can already sign on with any interactive provider today since P doesn't have a moat around its users.  Also keep in mind that interactive isn't one deal, but three separate deals it will need to hammer out with each of the labels.  In short, P may not be able finalize its deals by year end, at least at current market terms.  
  4. WHAT WE’RE KEYING IN ON: First, salesforce hiring, particularly on the local side since that has historically been P’s largest source Local Ad revenue growth, and may be a leading indicator for revenue growth over the coming quarters.  Mgmt suggested that is has roughly “155, 160 [local] sales people, or so” at a June 16th event, which suggests mgmt has curbed hiring (ended with 154 locals reps in each of the last 2 quarters).  Second, 2Q16 local sales rep productivity to see if there is a material inflection in the trend.  Third, anecdotal commentary on the timing on any interactive deals; specifically a change in tone.  For context, mgmt appeared to have had a progressively waning confidence level around the Web IV outcome at the end its prepared remarks in the last 3 earnings calls leading up the CRB decision; we're wondering if we will hear something comparable regarding interactive timing.  

  

Let us know if you have any questions, or would like to discuss further.

 

Hesham Shaaban, CFA
Managing Director


@HedgeyeInternet

 

P | Thoughts into the Print (2Q16) - P   Local Sales Prod 1Q16 

P | Thoughts into the Print (2Q16) - P   National Sales Prod 1Q16


NFLX | Closing Long (2Q16)

Takeaway: We got too cute trading around our thesis. 2Q16 was so bad that we suspect our thesis may play out much sooner than we originally expected.

KEY POINTS

  1. 2Q16 = JUST AWFUL: Both the print and our long call into it.  We bought NFLX as trade on expected upside to int’l net sub adds for both the 2Q print/3Q guide.  NFLX reported int’l net adds of 1.54M (-36% y/y decline) vs. consensus of 2.1M and issued 3Q guidance of 2M vs. our expectation of 3.5M.  US was much worse, with net adds at historical lows of 160K and 300K in the 2Q print/3Q guide, respectively.  Mgmt suggested its gross adds were inline with its expectations, but heighted churn preempting the price increases from the ungrandfathering of its plans led to the shortfall vs. its expectations.  Regardless of the reason, its int’l net subs adds are a big concern given that NFLX hadn’t annualized past many of its 2015 country launches, and it just launched to ROW in 1Q16.  The fact that net adds are down on a y/y basis despite these tailwinds casts new doubt on the longer-term int’l story.
  2. DEMAND = ELASTIC? We clearly underestimated the magnitude of churn in our two trackers this quarter; largely because we didn’t think a $1-$2 increase in the monthly rate would be a big deal for most of its subs.  The sub adds miss vs. guidance was the worst in NFLX’s reported history (both US and int’l on a % basis); suggesting mgmt was really caught off guard as well.  It’s too early to tell if churn will become a prolonged issue since over half of NFLX domestic subs are in grandfathered plans, and NFLX will be staggering the price increases.  But the 2Q16 churn issue casts new doubt over one of NFLX’s assumed levers to cover its longer-term content costs; demand may be more elastic than many of us had assumed.  Granted, we could be overreacting to the print, but given the backlash to such a relatively small monthly rate increase, we have to question NFLX’s pricing power. 
  3. THESIS REFRESH: The first two bullets suggest that NFLX may have a shorter runway on both int’l growth and its ability to take price down the road.  In the context of our thesis, it appears even less likely that NFLX’s model will survive in its current form, and more importantly, that the street will actually figure that out over the 2016-2017 period following its ROW launch.  NFLX's mounting contractual obligations aren't a secret; if int'l user growth sputters out further despite its ROW launch, the specifics of its content costs will likely receive more attention (first note below) as the street realizes that int'l can't compensate for waning US demand (second note).  We're actually shocked that the stock isn’t down more pre-market and that we haven't seen any downgrades on one of NFLX’s worst prints in recent memory.  That basically suggests that the street still has hope and/or is in denial about NFLX’s longer-term prospects, which also means that we may get another shot on the short side this year.

 

See the notes below for supporting detail around our thesis.  Let us know if you have any questions, or would like to discuss further.

 

Hesham Shaaban, CFA
Managing Director


@HedgeyeInternet

 

 

NFLX | Breaking Down Content Costs
05/26/16 08:14 AM EDT
[click here

 

NFLX | Good vs. Bad (US User Survey)
06/09/16 10:41 AM EDT
[click here

 

 


NFLX | New Trade Idea (Long)

Takeaway: This is just a short-term trade on what we believe to be a bullish setup into the 2Q16 print. Bearish thesis remains the same.

SUMMARY

We published a note last night discussing our thoughts into NFLX’s 2Q16 earnings release (same bullets below in case you missed it).  In short, we expect that strength in int’l net sub adds on the 2Q print/3Q guide to alleviate growing concerns around the longer-term NFLX story; most of which were introduced by the 2Q16 guidance release.  Granted, we expect the 3Q guide for US net subs to disappoint, but we don’t see that as a major headwind given the heightened level negative sentiment around the US story today.  We suspect the street would look past a miss on the 3Q US net subs guide as long as it isn’t worse than the 2Q guide; especially if NFLX produces upside to its 2Q US net adds metric as we expect, and more importantly shows progress with the int’l story.  In short, the Int'l story is now the new battleground in the name since it's the barometer to NFLX's longer-term viability given perceived pressures in the US.  That said, given the growing wave of negative sentiment around the story, we suspect the stock works as long as int'l works. 

 

 

nflx | THOUGHTS INTO THE PRINT (2q16)

  1. THESIS RECAP: We doubt NFLX will be able to sustain its model and/or the breadth of its content offering, and that's it 2016 ROW launch will put that into context over 2016/2017.  We see NFLX’s contractual obligations as a considerably understated proxy for the ongoing cost of running its business rather than a distinct set of milestones; especially since its content outlays profile more as recurring quarterly expenses rather than asset purchases.  That said, the viability of its model is dependent on its ability to realize its user TAM.  However, our analysis of the US market suggests it may only have limited near-term runway, making the int’l expansion story crucial.  NFLX has essentially accelerated the test case for whether that story will work into 2016/2017 with its ROW launch, so we suspect the story may be coming to a head this year.  If Int'l starts sputtering out, we suspect the hype around the longer-term story fizzles out, and the multiple gets sucked out of the stock.
  2. US DOES APPEAR TO BE UNDER PRESSURE: Consensus is expecting net subscriber adds to decline -41% y/y to 532K in 2Q (vs. guidance of 500K), followed by a -12% decline in 3Q.  Our trackers are suggesting that the US did decline at a decelerating rate in 2Q, but not quite at the pace implied by guidance/consensus.  The 3Q guide may be a different story though since consensus is expecting a considerable moderation in the y/y decline in US net adds, and our tracker suggests only marginal improvement in the y/y trend in 3Q vs. 2Q.  Granted it’s still early in 3Q, but given that NFLX reports so early in the quarter, we suspect mgmt would need to take a big leap of faith in order to guide consensus domestic 3Q net adds.  We’re expecting 2Q net adds to come in at roughly 650K, with the 3Q guide slightly below that (vs. consensus of 774K).
  3. BUT INT’L LOOKS MUCH BETTER: Consensus is expecting net adds to decline -11% y/y to 2.1M in 2Q (vs. guidance of 2.0M), followed by a 4% increase in 3Q.  Remember that NFLX hasn’t annualized past all of its 2015 country launches yet, so a y/y decline in 2Q seems overdone, especially considering its 2016 ROW launch.  While our trackers are pointing to decelerating 2Q growth, we’re not seeing declines outside of a few notable countries (UK, CA, AU), but that is being largely offset by elevated growth throughout Latin America.  Our trackers also suggest that those two themes are largely extending early into 3Q as well, however the decline in those countries mentioned above is moderating, while Latin American growth remains elevated, if not accelerating in certain countries on a y/y basis QTD.  Collectively, we’re expecting int’l net adds to approach 3M in 2Q, with the 3Q guide coming in around 3.5M (vs. consensus of 2.85M)
  4. 2Q16 = BULLISH SETUP? We suspect that sentiment around the US story is fairly muted at this point, so attention has shifted toward the int’l markets as the proxy for whether the longer-term NFLX story has any legs.  In turn, we suspect if int’l works then than the stock could work as well.  We know we’re not alone in expecting upside to 2Q int’l net sub adds, but the 3Q guide hasn’t gotten as much attention.  If NFLX guides to a 3-handle for 3Q int’l net sub adds, we suspect the int’l story will find rekindled optimism following the shell shock from the 2Q guide, which would likely appear as a hiccup and/or sandbag in retrospect.  Regarding the US story, it’s tougher to gauge how sentiment tracks from here since we’re expecting a miss on the 3Q net sub adds guide, which could propel the bear case around potential churn from NFLX’s planned price increases.  But we suspect the street could look past a miss on US net sub adds as long as the 3Q guide isn’t worse than the 2Q guide, especially if NFLX produces upside to its 2Q net adds metric as we expect, and more importantly shows promise around the int’l story.   

 

See the notes below for supporting detail around our thesis.  Let us know if you have any questions, or would like to discuss further.

 

Hesham Shaaban, CFA
Managing Director


@HedgeyeInternet

 

 

NFLX | Good vs. Bad (US User Survey)
06/09/16 10:41 AM EDT
[click here

 

NFLX | Breaking Down Content Costs
05/26/16 08:14 AM EDT
[click here


NFLX | Thoughts into the Print (2Q16)

Takeaway: We're bearish over 2016/2017, but our trackers suggest it's too early to short it here, and sentiment is so bad that we may go long tomorrow

KEY POINTS

  1. THESIS RECAP: We doubt NFLX will be able to sustain its model and/or the breadth of its content offering, and that's it 2016 ROW launch will put that into context over 2016/2017.  We see NFLX’s contractual obligations as a considerably understated proxy for the ongoing cost of running its business rather than a distinct set of milestones; especially since its content outlays profile more as recurring quarterly expenses rather than asset purchases.  That said, the viability of its model is dependent on its ability to realize its user TAM.  However, our analysis of the US market suggests it may only have limited near-term runway, making the int’l expansion story crucial.  NFLX has essentially accelerated the test case for whether that story will work into 2016/2017 with its ROW launch, so we suspect the story may be coming to a head this year.  If Int'l starts sputtering out, we suspect the hype around the longer-term story fizzles out, and the multiple gets sucked out of the stock.
  2. US DOES APPEAR TO BE UNDER PRESSURE: Consensus is expecting net subscriber adds to decline -41% y/y to 532K in 2Q (vs. guidance of 500K), followed by a -12% decline in 3Q.  Our trackers are suggesting that the US did decline at a decelerating rate in 2Q, but not quite at the pace implied by guidance/consensus.  The 3Q guide may be a different story though since consensus is expecting a considerable moderation in the y/y decline in US net adds, and our tracker suggests only marginal improvement in the y/y trend in 3Q vs. 2Q.  Granted it’s still early in 3Q, but given that NFLX reports so early in the quarter, we suspect mgmt would need to take a big leap of faith in order to guide consensus domestic 3Q net adds.  We’re expecting 2Q net adds to come in at roughly 650K, with the 3Q guide slightly below that (vs. consensus of 774K).
  3. BUT INT’L LOOKS MUCH BETTER: Consensus is expecting net adds to decline -11% y/y to 2.1M in 2Q (vs. guidance of 2.0M), followed by a 4% increase in 3Q.  Remember that NFLX hasn’t annualized past all of its 2015 country launches yet, so a y/y decline in 2Q seems overdone, especially considering its 2016 ROW launch.  While our trackers are pointing to decelerating 2Q growth, we’re not seeing declines outside of a few notable countries (UK, CA, AU), but that is being largely offset by elevated growth throughout Latin America.  Our trackers also suggest that those two themes are largely extending early into 3Q as well, however the decline in those countries mentioned above is moderating, while Latin American growth remains elevated, if not accelerating in certain countries on a y/y basis QTD.  Collectively, we’re expecting int’l net adds to approach 3M in 2Q, with the 3Q guide coming in around 3.5M (vs. consensus of 2.85M)
  4. 2Q16 = BULLISH SETUP? We suspect that sentiment around the US story is fairly muted at this point, so attention has shifted toward the int’l markets as the proxy for whether the longer-term NFLX story has any legs.  In turn, we suspect if int’l works then than the stock could work as well.  We know we’re not alone in expecting upside to 2Q int’l net sub adds, but the 3Q guide hasn’t gotten as much attention.  If NFLX guides to a 3-handle for 3Q int’l net sub adds, we suspect the int’l story will find rekindled optimism following the shell shock from the 2Q guide, which would likely appear as a hiccup and/or sandbag in retrospect.  Regarding the US story, it’s tougher to gauge how sentiment tracks from here since we’re expecting a miss on the 3Q net sub adds guide, which could propel the bear case around potential churn from NFLX’s planned price increases.  But we suspect the street could look past a miss on US net sub adds as long as the 3Q guide isn’t worse than the 2Q guide, especially if NFLX produces upside to its 2Q net adds metric as we expect, and more importantly shows promise around the int’l story.   

 

See the notes below for supporting detail around our thesis.  Let us know if you have any questions, or would like to discuss further.

 

Hesham Shaaban, CFA
Managing Director


@HedgeyeInternet

 

 

NFLX | Good vs. Bad (US User Survey)
06/09/16 10:41 AM EDT
[click here

 

NFLX | Breaking Down Content Costs
05/26/16 08:14 AM EDT
[click here


INVITE | EXPE Best Idea Long | Call TODAY at 11am EDT

The Hedgeye Internet & Media and Gaming, Lodging, and Leisure (GLL) teams will host a conference call TODAY, July 8th at 11am EDT to present EXPE as a new Best Idea Long. 

KEY POINTS OF DISCUSSION

  1. IT’S LARGELY A COST STORY: EXPE’s effective EBITDA target is much lower than its stated guidance range after considering specific inorganic tailwinds.  EXPE could hit that target largely on the cost side alone through its strategy to cut redundant/duplicate costs, but it also has two big levers it can pull that could drive upside to its target; neither of which has received much attention.  In short, mgmt is largely in control here.
  2. PAY TO PLAY: The AWAY model transition presents a considerable near-term opportunity.  While there is some execution risk from pushback amongst AWAY’s current subs, we will detail why EXPE likely holds all the cards here.  Timing issue may curb the 2016 opportunity, but our analysis suggests that very small progress with the transition will go a long way toward proving out EXPE's EBITDA target and validating the bull-case narrative.  Once again, mgmt is largely in control here as well.
  3. THE END ISN’T NIGH: We suspect most outside of the sell-side are already bracing for softening travel trends.  Mgmt had already guided to decelerating room night growth through 2016 and cautioned of softening travel trends at a recent investor event, which was corroborated by the STR data that we’re all watching.  But there is another layer to the current travel trends that is going largely unnoticed.  Further, EXPE may currently be the OTA best positioned to weather any emerging global travel headwinds, which we will also discuss during our call.  

Attendance on this call is limited. Ping  for more information.


*INVITE | EXPE Best Idea Long | Call Friday at 11am EDT

Takeaway: Time of the call is tomorrow July 8th at 11am EDT

The Hedgeye Internet & Media and Gaming, Lodging, and Leisure (GLL) teams will host a conference call tomorrow, July 8th at 11am EDT to present EXPE as a new Best Idea Long. 

KEY POINTS OF DISCUSSION

  1. IT’S LARGELY A COST STORY: EXPE’s effective EBITDA target is much lower than its stated guidance range after considering specific inorganic tailwinds.  EXPE could hit that target largely on the cost side alone through its strategy to cut redundant/duplicate costs, but it also has two big levers it can pull that could drive upside to its target; neither of which has received much attention.  In short, mgmt is largely in control here.
  2. PAY TO PLAY: The AWAY model transition presents a considerable near-term opportunity.  While there is some execution risk from pushback amongst AWAY’s current subs, we will detail why EXPE likely holds all the cards here.  Timing issue may curb the 2016 opportunity, but our analysis suggests that very small progress with the transition will go a long way toward proving out EXPE's EBITDA target and validating the bull-case narrative.  Once again, mgmt is largely in control here as well.
  3. THE END ISN’T NIGH: We suspect most outside of the sell-side are already bracing for softening travel trends.  Mgmt had already guided to decelerating room night growth through 2016 and cautioned of softening travel trends at a recent investor event, which was corroborated by the STR data that we’re all watching.  But there is another layer to the current travel trends that is going largely unnoticed.  Further, EXPE may currently be the OTA best positioned to weather any emerging global travel headwinds, which we will also discuss during our call.  

Attendance on this call is limited. Ping  for more information.


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