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Netflix Jettisons Anti-ad Principles to Cope With Lean Times




As he built Netflix into the world’s biggest streaming service, one of Reed Hastings’ management mantras was for his staff to “tell the emperor when he has no clothes”.

With Netflix losing almost two-thirds of its market value since November and analysts likening its fall to the dotcom crash, Hastings on Tuesday finally heeded his own advice and admitted that his corporate strategy might be seriously underdressed.

In the course of an hour on Tuesday, the Netflix founder and chief executive jettisoned his long-cherished principles, reorienting a media group that changed Hollywood to cope with leaner times of slow growth and spending restraint.

Sharing passwords? In 2016, Hastings quipped “we love people sharing Netflix”. Now, he plans to crack down on the practice; Hastings estimated 100mn people have been sharing accounts.

Competition? For years he has dismissed the threat of Disney, Apple and HBO, insisting Netflix’s biggest competitors were Fortnite, YouTube and “sleep”. On Tuesday he admitted Netflix needs to “take it up a notch” because its competitors have “some very good shows and films out”.

But perhaps the clearest about-turn was on advertising. Having always defended Netflix as an advertising-free zone that allows viewers to “relax” without being “exploited”, Hastings flung open the doors to marketing money.

Casually dropping the change of strategy during a call with analysts, Hastings announced Netflix would work on a cheaper, advertising-backed version of its service “in the next year or two”.

Netflix has been applauded for its original TV shows and films, such as the series ‘Inventing Anna’, but this week the company said it would curb its spending on content © Nicole Rivelli/Netflix

And spending? Netflix single-handedly created a template for streaming in which the stock market rewarded it for spending more money. The company burnt cash for years while investors applauded its fast subscriber growth and commitment to steadily churning out fresh TV shows and movies. For the first time, the company on Tuesday said it would curb its spending on content.

“It was shocking,” summarised Michael Nathanson, analyst at MoffettNathanson. “These guys sounded like any other management team that just didn’t have the answers yet.”

The volte-face is a humbling moment for a company that while its subscriptions soared at the height of the pandemic was confident enough to begin proactively cancelling accounts for people who were not using them.

After a historic stock market run as one of the big tech ‘FAANG’ companies (Facebook, Apple, Amazon, Netflix and Google) soaring to a valuation of nearly $310bn in October, it has shrunk back to $95bn. Shares in Netflix plunged more than 38 per cent on Wednesday alone.

“We have watched a company go from growth darling to growth purgatory in an instant,” said Nathanson.

One of the most painful decisions for Hastings may have been on advertising.

His rivals had long predicted Netflix would eventually buckle on an anti-advertising position that Jason Kilar, the former chief executive of Warner Media, recently compared to a “religion”. But few imagined it would come so soon.

“The way you get a billion [subscribers] is not by continuing to charge a premium price that’s ad-free,” Kilar said. “[Netflix] will absolutely get to that conclusion.” 

Morgan Stanley expects that in the long term, Netflix can make “billions” from advertising, estimating that adverts generate about $3bn in revenue a year for rival service Hulu.

But the bank’s analysts also questioned whether the option to offer cheaper subscriptions would boost revenues for the company, given that it has already convinced 75mn households in the US and Canada to pay on average $15 a month. “As it migrates customers to an ad-supported tier at a lower price point, can it generate higher overall [revenue]? This is less clear.”

Mark Read, chief executive of the WPP advertising group, said the change in strategy reflected the need to reach new customers and the clear “limits to growth of subscription-only models”. 

“History has shown that successful media companies have both subscription and advertising,” he said. “No doubt the pressure on household budgets as well as the increasing number of subscription offers has focused consumer minds.”

The challenge for Netflix is to introduce the ad-supported tier of membership without either eating into its existing subscriber base, or devoting too much time and money into building an advertising business that it once saw as a distraction.

After years as a market leader in video subscription services, Netflix must adjust to the role of latecomer in ad-funded streaming, learning from Disney, Discovery, Paramount and NBC. “There was never any fear that we’re in trouble,” said one former Netflix executive. “The feeling was: we are leap years ahead.” 

It now faces stiff competition from the world’s largest media and technology companies, which have found success with blockbuster television shows such as Apple’s Ted Lasso and HBO’s Succession

Among some investors and analysts, there is a sense that Netflix’s lavish spending should yield better programming. “If you spend $18bn on content, I would like to think that you can persuade people to join your streaming platform,” said a top-10 shareholder in Netflix.

But its share price crash is worrying for the entire entertainment industry, because the biggest US media groups have earmarked more than $100bn for spending on content this year alone to try to emulate Netflix’s model.

Now, Hollywood is questioning whether Netflix executives seriously overestimated the size of the streaming market.

Netflix has 222mn paying subscribers, and Hastings has told investors that his “total addressable market” was any household in the world with access to the internet — potentially a billion subscribers. There was plenty of room to grow, and ample space for new competitors, he insisted.

But as its growth has ground to a halt, analysts are poking holes in these optimistic assumptions. Given questions of affordability and global access to digital payment systems, Nathanson estimates that the “real” addressable market is closer to 400mn.

Equally worrying, he questions whether Netflix has already reached full saturation in the US and Canada, where the company revealed on Tuesday that an additional 30mn people are sharing accounts on top of its existing 75mn subscribers. The number of US pay-TV subscribers during the peak of television in 2011 was about 100mn, indicating Netflix may have tapped out in its largest market.

This is bad news for other media groups because their valuations have been benchmarked on Netflix. Shares in Warner Bros Discovery fell 5 per cent on Wednesday, while Disney was down 4 per cent and Paramount Global lost 10 per cent.

Rich Greenfield, an analyst at Lightshed partners, noted the irony that streaming champions such as Netflix and Disney were now embracing advertising, a key pillar of old-media strategy, to revive their businesses.

“It is scary if the only way to reinvigorate growth is offering cheaper products that worsen the consumer experience, essentially making it more like the dying linear TV experience,” he said.

Additional reporting by Harriet Agnew

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How Retail Stocks Went From ‘recessionary Playbook’ to Market Casualty





Richard Thalheimer remembers the last time inflation was proving so challenging to US retailers: it was when he was trying to get The Sharper Image off the ground in the late 1970s and 1980s. 

In 2006 he left the consumer gadgets chain he founded, selling his stake before its 2008 bankruptcy. Ever since, he has been investing the proceeds of the watches, massage chairs, iPods and Razor scooters he sold, building a portfolio worth up to $350mn with stocks including Amazon, RH and Home Depot.

“It’s been so much fun,” he said. “Until this year”. 

As inflation races at levels last seen four decades ago, the retail sector that made Thalheimer wealthy is now making other investors poorer and stoking recession fears. This week, unexpectedly bad earnings announcements from Walmart and Target, two of its largest constituents, led to their steepest stock market falls since Black Monday in 1987.

Days earlier, analysts had been touting such companies as defensive shelters from the storm in tech stocks that had slashed the valuations of companies from Amazon to Netflix. Early this week, Baird named Walmart its top “recessionary playbook” idea.

But the shockwaves from Walmart and Target rippled through the wider retail sector and gave market bears a new concern: that inflation may now be biting consumers even before the Federal Reserve starts raising interest rates more aggressively.

Retailers were the biggest drivers of a broad market rout on Wednesday that pushed the S&P 500 stock index to its worst one-day fall in almost two years.

Until this week, the S&P 500’s consumer staples sub-index, which includes “big box” retailers such as Walmart along with businesses like pharmacies and food manufacturers, was still roughly unchanged for the year. The only other parts of the index that had avoided declines were energy and utility stocks, which had benefited from surging energy prices.

By the close of Thursday, however, the sub-index had fallen almost 9 per cent and was on track for its worst week since the start of the coronavirus pandemic in March 2020.

The retailers’ earnings flagged up not just one cause for concern, but three: that price increases may have reached the limit of what consumers will tolerate, that retailers are struggling to contain their own costs, and that unpredictable demand and new supply disruptions are forcing them to build up inventories.

The first of those three is being most closely watched for its broader economic resonance. “You’ve got a consumer that is starting to pull back,” said Steve Rogers, head of Deloitte’s consumer industry centre, whose surveys suggest that 81 per cent of Americans are concerned about rising prices.

Americans’ bank accounts may not have changed dramatically since last year, he said, but headlines about inflation have shaken their confidence. Some are trading down or holding off big purchases as a result, he added, particularly in discretionary categories such as clothing, personal care and home furnishings.

Walmart, long seen as a bellwether of the US consumer, noted that high inflation in food prices “pulled more dollars away from [general merchandise] than we expected as customers needed to pay for the inflation in food”. 

Rogers and others, however, see retailers’ own cost pressures as a clearer driver of their changed fortunes than consumer pullback. At Walmart, for example, US fuel costs last quarter were over $160mn higher than it had expected — more than it could pass through to customers.

“We did not anticipate that transportation and freight costs would soar the way they have,” echoed Target’s chief executive Brian Cornell. Higher wages and costs for containers and warehouses are also weighing on retailers’ profit margins.

Some of those higher costs stem from the third force at work: a disrupted global supply chain that has left retailers scrambling to secure stock at a moment when demand for it is uncertain. “Their inventories are exploding,” Cathie Wood, chief investment officer at Ark Invest, wrote in a Twitter post on Walmart and Target.

The reason for carrying more inventory than usual is that “they lived through the stock-outs of the past two years and know what that cost them”, said Rogers.

Walmart chief executive Doug McMillon indicated that some of the build-up was deliberate, saying: “We like the fact that our inventory is up because so much of it is needed to be in stock.” Still, he admitted, “a 32 per cent increase is higher than we want”. 

Target’s inventories rose even further, up 43 per cent from a year earlier, and it conceded that it had failed to anticipate consumer spending shifts in categories from televisions to toys.

“We aren’t where we want to be right now, for sure,” said Target chief operating officer John Mulligan, adding that “slowness in the supply chain” had forced it to carry more stock as a precaution.

Wayne Wicker, chief investment officer at pension plan manager MissionSquare Retirement, said it should not be surprising to see signs of consumers reining in some spending, but said this week’s results were nonetheless a “wake-up call” for some investors because many companies had until recently claimed they were handling inflation challenges well.

Walmart and Target both provided upbeat forecasts in their previous quarterly update, and did not pre-announce any changes before this week’s reports.

“Part of the price decline was reflecting the fact that the management of these large companies didn’t provide any indication that they were going to have such a miss,” Wicker said.

For Denise Chisholm, Fidelity’s director of quantitative strategy, this week’s reports did not provide convincing evidence that the economy is in trouble, but they spooked investors who were already nervous after earlier sell-offs.

Despite the visceral market reaction to Target’s results, for example, its new lower forecasts would only return profit margins to pre-pandemic levels.

“If there’s any differentiating factor compared with [previous bear markets], it has been the strength of earnings, so any kind of concern over earnings gives more volatility from a near-term perspective,” Chisholm said. But, she added, “despite a lot of the concern in the market, it is hard to reach an empirical conclusion that says recession is any more likely given what we’ve seen”.

Thalheimer, whose portfolio is down by about $50mn from its peak, thinks markets overreacted this week and is already wondering when it will be time to consider snapping up beaten-down retail stocks.

“During most of the big sell-offs of my lifetime — 2009, the [bust following the] dotcom bubble or 1987 — almost every one of these times within two years you [saw] very strong recoveries,” he said.

That will happen again, he believes, but with the combined uncertainties around supply chains, the war in Ukraine and historic inflation, “there are going to be some choppy waters ahead”.

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Investors Spooked As Gloom Grips Markets





One of the more annoying things that investors do when they have been in the game for a really long time is to pooh-pooh market skirmishes.

“You think this is bad? Pah! You should have seen Black Monday/Soros taking down sterling/the dotcom crash,” etc. If this happens to you, my advice is to change the subject at precisely this point, before the segue into how much more fun markets were “back in my day” and how young people nowadays “know nothing”.

The veterans do have a point: a generation of traders and fund managers have never seen full-blown inflation and are accustomed to the mantra that stocks only go up (or to central banks saving the day if they stumble). But even the old-timers accept that right now we are at a historic juncture.

In part, that is because of the sheer scale of some of the market moves. The S&P 500 benchmark index of blue-chip US stocks has fallen by 19 per cent already this year. This pace may not continue. But if it does, it will be heading towards 2008’s 38 per cent fall. More tech-heavy indices like the Nasdaq Composite have fared even worse — it is down 27 per cent. Pass the smelling salts.

Individual stocks are taking a beating, particularly when companies release iffy numbers. Pandemic lockdown-era favourites such as Peloton have gone into meltdown. The manufacturer of domestic perspiration is down 90 per cent over the past year. Coinbase, Robinhood . . . take your pick. It is a mess.

But what has really spooked investors now is US retailer Target, which suffered a 25 per cent cratering in its share price just in one day this week when it said profits had halved in the first quarter and warned that profits in future quarters would suffer as a result of rising costs. 

Fellow retailer Walmart had sounded a similar alarm on the previous day, driving its shares down by 11 per cent — not to be sniffed at. Still, for some reason Target cut through. Suddenly investors accept that the slide in asset prices triggered by the US Federal Reserve’s arguably belated response to soaring inflation will prove deep and broad.

Possibly most alarming, though, is the nature of the reckoning. Hedge fund group Man wrote this week that since 1960, there have been 44 times when the S&P 500 has fallen for five or more consecutive weeks. US government bonds, meanwhile, have dropped in the same way just 31 times since 1973.

“Yet these prolonged sell-offs had never coincided — until the start of May,” number crunchers at the Man Institute wrote. Adherents to the classic portfolio split — 60 per cent stocks, 40 per cent bonds — have not had it so bad in half a century. So now what? “As it has never happened before, we cannot look back for historical guides to what happens next,” Man said. Oh.

This is seriously unsettling stuff. Bank of America described the mood in its latest monthly investor survey as “extremely bearish”. It found the highest allocations to cash — the ultimate hiding place from trouble — since 9/11 and the biggest negative view on big tech stocks since August 2006, beyond what was seen in the financial crisis or the height of the pandemic. Fund managers also reported their biggest underweight position on equities since May 2020. 

“The challenge for us is not one sector but the change in market regime,” said Hendrik du Toit, chief executive at asset manager NinetyOne, this week. “It’s so volatile right now . . . that it’s very difficult to apply a systematic process and get an expected result.”

He added: “I think with central banks being behind, we are in for quite a painful period and that means . . . the little bubbles that existed all over the place are going to be squeezed out brutally.” Crypto is just the start here, he suggests.

For investors with a mandate that allows them to do it, one of the few mainstream ways to avoid a battering is commodities, an asset class that has lain unloved for years. In part, that is because returns have been drab. But avoiding commodity stocks or bets on the direction of fossil fuels or metals also has been an easy way to burnish sustainable investment credentials.

Now we are seeing some verbal acrobatics, along the lines that there’s no point buying stocks in electric vehicle makers while refusing to buy the miners that get the metals those carmakers need. This sounds bonkers but does make sense. 

In any case, driven desperate by inflation, investors do appear willing to jettison or tweak their principles and jump in. Commodity specialists who have barely been able to get asset allocators to take their calls for the past decade are suddenly in demand. “Performance has been really bad for the last 10 years. We didn’t raise a dime in the asset class,” says Hakan Kaya, a senior portfolio manager focused on commodities at Neuberger Berman. Now he’s seeing lots of interest, from investors as diverse as pension funds and wealthy individuals.

“We are not living in a nice period like 2008 to 2020 where stocks and bonds are doing fine,” he says. “Instead they are doing badly because inflation is resurfacing. No surprise there, right? People are looking for buffers against inflation.”

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