As mentioned earlier, instead of a lengthy discussion of macro conditions and how his investment strategy is changing in 2020 as a result of the Fed's latest intervention in capital markets, Greenlight's David Einhorn presented an extensive recap of his top 10 largest positions on both the long and short side. While readers can read the full list in the pdf below, we focus on three of these - Einhorn's continuing feud with Netflix, which has been a staple member of Einhorn's short basket and to which Einhorn added even more shorts during the late-2019 bounce, as well as his view on corporate credit and finally, his ongoing infatuation with gold (which was reinforced earlier today with Ray Dalio's latest Davos comments).
Netflix (NFLX) – Short
59x P/E on 2020 GAAP estimates, which we believe dramatically overstate the business economics
We have been negative on NFLX’s earnings prospects for a long time, and we used the late-2019 bounce in the shares to make it a more substantial investment. For years, NFLX has been an open-ended growth story, where the value of a subscription was considered to be underpriced and bulls could dream about future subscriber totals in the context of the global population. The market celebrated NFLX as the king of a perceived “winner-take-all” (or “winner-take-most”) global market for streaming video-on-demand (VOD).
We believe this narrative is finally coming to an end. NFLX is no longer the only value-priced streaming VOD provider. There are now a half-dozen subscription services and in the coming year there will be additional credible entrants with deep content libraries. Not every customer will choose to subscribe to all services, and on the margin, substitution will occur. We believe that new competitors have already hurt NFLX in the U.S. Following an unexpected Q2 subscriber loss and in response to management’s apparent optimism, analysts raised estimates for U.S. growth; as recently as September, consensus expected NFLX to add 1.5 million new customers in the fourth quarter. Instead, in October, the company guided to just 600,000. Still, Wall Street cheered the lowered guidance because it was deemed to be “conservative.” In fact, the CEO ended the conference call by saying he looked forward to “blowing away” the guidance.
It appears to us that new subscriptions are slowing and cancellations are accelerating. Competition is denting the NFLX domestic story, just as the platform loses its two most popular shows, Friends (in 2020) and The Office (in 2021), forcing management to spend aggressively to create and market binge-and-forget Netflix Originals and stand-up comedy specials, which lack staying power. In response, management has decided to stop disclosing U.S. margins and subscriber totals beginning in 2020.
International subscriptions will continue to grow, but those customers are far less valuable than domestic subscribers, in large part because the revenue per user is lower in international developed markets and much lower in developing markets. Even so, international subscriber growth is now decelerating as well. As NFLX has to compete for subscribers to maintain user growth, the pricing-power narrative should increasingly come undone.
In what appears to be a desperate attempt to achieve international subscriber growth headlines, the company recently launched sub-$4 per month mobile-only plans in Thailand, Malaysia and Vietnam, and in December NFLX began offering up to 50% annual subscription discounts in India. Obviously, the marginal economics on these new subs are… marginal.
To the extent the market sees the NFLX growth story as “busted,” there is a lot of downside to the shares. At present, NFLX burns several billion dollars a year in cash and has accumulated a heavy debt load, even before considering future content commitments. Of course, NFLX could service the debt and de-lever by raising equity – but doing so would be a cold admission that the party is over. We doubt management will rush to do that.
Second, while much of the panic surrounding the avalanche of fallen angels and overvalued junk credits appears to have faded for the time being, largely thanks to the Fed's boosting of all risk assets, Einhorn begs to differ and has a short basket in a variety of credit securities:
Credit Short – Macro
We have short positions in indices that track U.S. corporate investment grade and high-yield credit. Credit spreads are at cyclical tights even though (a) the economy appears to be decelerating, (b) we are far along in the economic cycle, (c) corporate debt has exploded, and (d) rating agencies have been complacent by allowing debt/EBITDA ratios to expand without downgrading the underlying credits. At current spreads, we believe that the risk/reward in corporate credit is asymmetric and unfavorable. This short also provides a de facto macro hedge to some of our cyclical or credit-sensitive longs including BHF, CC and GM.
Finally, picking up where Dalio left off, here is why Einhorn remains long gold for yet another year:
Gold – Long
U.S. total public debt to GDP is over 100%. With unemployment at record lows, the U.S. is running an almost $1 trillion annual deficit. The bipartisan consensus is that deficits don’t matter – it implies we can always print our way out of trouble. Meanwhile, although the Federal Reserve Bank’s balance sheet is very large and interest rates are already low, the Fed has cut interest rates and begun expanding its balance sheet again. All told, we can count on aggressive fiscal and monetary policies in both good times and bad. Gold continues to be a hedge in our portfolio against adverse outcomes related to those policies.
Finally, for those wondering, Einhorn discloses the fund's top positions, which at quarter-end, were AerCap, Brighthouse Financial, General Motors, gold and Green Brick Partners. The Partnerships had an average exposure of 127% long and 63% short.
The full letter is below.