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@tsoh_investing
The Science of Hitting
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The Science of Hitting
$25.7MFollowers
@tsoh_investing04/25/2022
Netflix: "This Is When It All Matters" $NFLX
In June 2004, Netflix announced the first price hike for its standard DVD subscription service (+10%, from $19.95 per month to $21.99 per month).

But just five months later, Netflix reversed course.

As a result of a “changing competitive landscape” (a resurging Blockbuster, along with incursions by Walmart and Amazon), the company announced in November that the price would be lowered to $17.99 (they also introduced a lower-tier that allowed access to two DVD’s at a time for $11.99 a month). As noted in a 2005 CNN Money article, that was an ominous signal: “Price wars in tech are never a good sign.” In the 2004 shareholder letter (back when Netflix had ~2.6 million subscribers and ~$500 million in sales), management spent a fair amount of time discussing the competitive dynamics within the DVD market (“2004 was also a year in which we demonstrated our willingness to make hard choices — including lowering prices and deferring profitability — to protect our market leadership.”). But while Netflix’s streaming (SVOD) service wouldn’t launch for another three years, it was already clear by that point that management had their sights set on a bigger prize: “delivering a superior home entertainment experience”.

In the 2005 annual report, management wrote the following:

“We also anticipate the emergence of a significant downloading market once two primary hurdles are cleared: the availability of deep and compelling content and the technological challenge of getting the content from the Internet to the TV, where people want to watch it. We are absolutely focused on positioning Netflix to lead this market. It’s important to remember that downloading is just another way to deliver content, an alternative to the mail, or the local video store, or to cable, or to satellite delivery. The winners in downloading will be the companies that provide the best content and the best consumer experience, and that’s what we do best. With millions of online subscribers addicted to the Netflix Web site, we will have both a mass audience and the most compelling consumer experience in the market, which will give us critical advantages as we begin to offer downloading as a second delivery option.”

Jumping to the present, we can see that Netflix’s “absolute focus” on the streaming market has paid off. In Q1 FY22, the company reported that their customer base reached 222 million paid subscribers around the world, an increase of ~180% over the past five years (note that the company shut down its Russian service in Q1, which was a ~700k hit to the sub base).

But as that second chart shows, the pace of subscriber growth has slowed meaningfully in the past 18 months; what was once assumed to be a temporary hangover from the pandemic now appears to be a larger issue. For context, here’s what I wrote about Netflix’s sub growth back in June 2021:

“One thing to consider as we think about the future is whether we’re resetting a base to grow off of (above 54 million net adds every two years) or if we’ve flatlined around that level. That’s not an unimportant question to answer, particularly as it relates to the TAM. Naturally, if you comp against a large and growing base, adding 27 million net subscribers every 12 months will have less of an impact on the growth rate than it did a few years earlier. This is bound to happen over time - you can’t add tens of millions of subs in perpetuity - but if it’s happening now, that’s a notable development. We’ll see if a meaningful increase in the number of content releases in 2H 2021 and into 2022 can provide investors with some reassurances on that front.”

In hindsight, the idea of leveling off at 25-30 million net adds per year looks overly optimistic (to say the least). The fact that CFO Spencer Neumann felt the need to reiterate that there will be revenue growth and paid net adds in 2022 is telling. This significant change in expectations has (rightly) led to consternation in the market, with NFLX down ~70% from its 2021 highs.
As always, my primary objective is to try and understand what this all means for a long-term investor / business owner; in this post, I will try and answer four key questions: (1) What just happened? (2) What are the long-term implications for Netflix? (3) What are the long-term implications for the industry? (4) Does this materially change the long-term investment thesis?

post mediapost media
thescienceofhitting.com
Netflix: "This Is When It All Matters"
In June 2004, Netflix announced the first price hike in the company’s history for its standard DVD subscription service (+10%, from $19.95 per month to $21.99 per month). But just five months later, Netflix reversed course; as a result of a “changing competitive landscape” (a resurging Blockbuster, along with incursions by Walmart and Amazon), the company announced in November 2004 that the price would be lowered to $17.99 (they also introduced a lower-tier that allowed subscribers access to two DVD’s at a time for $11.99 a month). As noted in a 2005 CNN Money article, that was an ominous signal: “
Undefined
@eggplant04/25/2022
This was one of my favourite pieces yet, and really highlighted to me the value of your service. Found myself pondering, after the NFLX earnings, I wonder what Alex has to say. This morning, I got to find out :)
+ 2 comments
The Science of Hitting's avatar
The Science of Hitting
$25.7MFollowers
@tsoh_investing04/25/2022
Netflix: "This Is When It All Matters" $NFLX
In June 2004, Netflix announced the first price hike for its standard DVD subscription service (+10%, from $19.95 per month to $21.99 per month).

But just five months later, Netflix reversed course.

As a result of a “changing competitive landscape” (a resurging Blockbuster, along with incursions by Walmart and Amazon), the company announced in November that the price would be lowered to $17.99 (they also introduced a lower-tier that allowed access to two DVD’s at a time for $11.99 a month). As noted in a 2005 CNN Money article, that was an ominous signal: “Price wars in tech are never a good sign.” In the 2004 shareholder letter (back when Netflix had ~2.6 million subscribers and ~$500 million in sales), management spent a fair amount of time discussing the competitive dynamics within the DVD market (“2004 was also a year in which we demonstrated our willingness to make hard choices — including lowering prices and deferring profitability — to protect our market leadership.”). But while Netflix’s streaming (SVOD) service wouldn’t launch for another three years, it was already clear by that point that management had their sights set on a bigger prize: “delivering a superior home entertainment experience”.

In the 2005 annual report, management wrote the following:

“We also anticipate the emergence of a significant downloading market once two primary hurdles are cleared: the availability of deep and compelling content and the technological challenge of getting the content from the Internet to the TV, where people want to watch it. We are absolutely focused on positioning Netflix to lead this market. It’s important to remember that downloading is just another way to deliver content, an alternative to the mail, or the local video store, or to cable, or to satellite delivery. The winners in downloading will be the companies that provide the best content and the best consumer experience, and that’s what we do best. With millions of online subscribers addicted to the Netflix Web site, we will have both a mass audience and the most compelling consumer experience in the market, which will give us critical advantages as we begin to offer downloading as a second delivery option.”

Jumping to the present, we can see that Netflix’s “absolute focus” on the streaming market has paid off. In Q1 FY22, the company reported that their customer base reached 222 million paid subscribers around the world, an increase of ~180% over the past five years (note that the company shut down its Russian service in Q1, which was a ~700k hit to the sub base).

[


[


But as that second chart shows, the pace of subscriber growth has slowed meaningfully in the past 18 months; what was once assumed to be a temporary hangover from the pandemic now appears to be a larger issue. For context, here’s what I wrote about Netflix’s sub growth back in June 2021:

“One thing to consider as we think about the future is whether we’re resetting a base to grow off of (above 54 million net adds every two years) or if we’ve flatlined around that level. That’s not an unimportant question to answer, particularly as it relates to the TAM. Naturally, if you comp against a large and growing base, adding 27 million net subscribers every 12 months will have less of an impact on the growth rate than it did a few years earlier. This is bound to happen over time - you can’t add tens of millions of subs in perpetuity - but if it’s happening now, that’s a notable development. We’ll see if a meaningful increase in the number of content releases in 2H 2021 and into 2022 can provide investors with some reassurances on that front.”

In hindsight, the idea of leveling off at 25-30 million net adds per year looks overly optimistic (to say the least). The fact that CFO Spencer Neumann felt the need to reiterate that there will be revenue growth and paid net adds in 2022 is telling. This significant change in expectations has (rightly) led to consternation in the market, with NFLX down ~70% from its 2021 highs.
As always, my primary objective is to try and understand what this all means for a long-term investor / business owner; in this post, I will try and answer four key questions: (1) What just happened? (2) What are the long-term implications for Netflix? (3) What are the long-term implications for the industry? (4) Does this materially change the long-term investment thesis?

post mediapost media
thescienceofhitting.com
Netflix: "This Is When It All Matters"
In June 2004, Netflix announced the first price hike in the company’s history for its standard DVD subscription service (+10%, from $19.95 per month to $21.99 per month). But just five months later, Netflix reversed course; as a result of a “changing competitive landscape” (a resurging Blockbuster, along with incursions by Walmart and Amazon), the company announced in November 2004 that the price would be lowered to $17.99 (they also introduced a lower-tier that allowed subscribers access to two DVD’s at a time for $11.99 a month). As noted in a 2005 CNN Money article, that was an ominous signal: “
The Science of Hitting's avatar
The Science of Hitting
$25.7MFollowers
@tsoh_investing04/23/2022
Netflix vs HBO
Seeing a lot of commentary that implies $NFLX is losing ground relative to peers like HBO, so thought it might be helpful to pull some data. At the end of fiscal 2016, the gap between Netflix's annual revenues (~$9.4 billion) and HBO's annual revenues (~$5.9 billion) was ~$3.5 billion. Today, that gap is ~$23 billion; it has widened in every quarter for the past 5+ years.
post mediapost media
Jannis Meindl
@meindl_jannis04/23/2022
Is there an argument to be made that the market is just saturated and expansion across geographies is turning out to be challenging?
+ 10 comments
The Science of Hitting's avatar
The Science of Hitting
$25.7MFollowers
@tsoh_investing04/21/2022
$ALLY: "A Permanent Change"
In December 2021, I wrote the following in the conclusion of my Ally Financial deep dive (“Ally: A Banking Transformation”):

“Over the past five years, Ally has taken significant market share within U.S. retail deposits, with a trailing CAGR in the mid-teens. In addition, they’ve posted solid net interest margins, largely reflective of an improvement in their cost of funding. Finally, the company is in a position where it can aggressively return capital to shareholders, with ~$3.2 billion of repurchases from 2016 – 2020 at an average cost of ~$25 per share. (Through the first nine months of FY21, Ally repurchased another ~$1.4 billion.) At ~$46 per share, the stock trades at ~1.1x tangible book. If you believe normalized ROTCE’s in the mid-teens (%) are sustainable, as I do, that implies a normalized P/E in the single digits. Personally, I expect TBVPS and EPS to increase at double digit annualized rates for the foreseeable future (since YE16, TBVPS has increased >50%).”

On to today’s update, which will review Ally’s Q1 FY21 results.

A key component of the thesis, as outlined in the deep dive, is continued growth in Ally’s retail deposit base. At the end of Q1, retail deposits totaled $136 billion (up ~2x over the past five years), with 2.5 million retail customers across the franchise (the customer count has increased every quarter for the past 13 years, with ~70% of new customers from millennial or younger generations). However, as shown below, the pace of deposit growth in Q1 (+6% YoY) was well below the results we’ve come to expect from the franchise. While there are some short-term considerations that deserve our attention (timing of tax payment outflows), I will reiterate that outsized long-term retail deposit growth is a key pillar of my investment thesis. (“The ability to offer a superior product in the form of competitive deposit rates, lower fees, and a better overall user experience, is key to Ally’s continued share gains in the U.S. retail deposit market; a more efficient model (cost structure) is fundamental to being able to deliver on this promise over the long run.”)

(end of preview)

post mediapost media
thescienceofhitting.com
Ally: "A Permanent Change"
In December 2021, I wrote the following in the conclusion of my Ally Financial deep dive (“Ally: A Banking Transformation”): “Over the past five years, Ally has taken significant market share within U.S. retail deposits, with a trailing CAGR in the mid-teens. In addition, they’ve posted solid net interest margins, largely reflective of an improvement in their cost of funding. Finally, the company is in a position where it can aggressively return capital to shareholders, with ~$3.2 billion of repurchases from 2016 – 2020 at an average cost of ~$25 per share. (Through the first nine months of FY21, Ally repurchased another ~$1.4 billion.) At ~$46 per share, the stock trades at ~1.1x tangible book. If you believe normalized ROTCE’s in the mid-teens (%) are sustainable, as I do, that implies a normalized P/E in the single digits. Personally, I expect TBVPS and EPS to increase at double digit annualized rates for the foreseeable future (since YE16, TBVPS has increased >50%).”
The Science of Hitting's avatar
The Science of Hitting
$25.7MFollowers
@tsoh_investing04/19/2022
Some $NFLX Charts
Full update coming for TSOH subs on Monday morning ($ALLY on Thursday)

post mediapost media
thescienceofhitting.com
TSOH Investment Research Service | The Science of Hitting | Substack
Long-term investment research with 100% transparency (prior disclosure of all portfolio changes). TSOH is written by Alex Morris, a former buyside equities analyst and CFA Charterholder. Click to read TSOH Investment Research Service, by The Science of Hitting, a Substack publication with tens of thousands of subscribers.
Undefined
@eggplant04/19/2022
Monday morning! Fast turnaround. Can’t wait to read it. Avoiding the hot takes on Twitter until then.

Side note, would love to hear if you have comments on ad-support.
+ 1 comment
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The Science of Hitting
$25.7MFollowers
@tsoh_investing04/18/2022
Roblox: The YouTube of Gaming?
A few weeks ago, in preparation for this deep dive, I created a Roblox account. Within minutes, I was immersed in a seemingly unending world of virtual experiences (most of which can be fairly categorized as games). I drove around town doing my rounds as a taxi driver, I was a solider in a shooter that resembled a low-quality version of Call of Duty (CoD), and I was the left fielder in a baseball game with 17 other users (in my first at bat, I struck out looking on a 3-2 count; “no called strikes” only applies to investing).

Honestly, I found the experience underwhelming. When I was dropped into these virtual worlds, it took me awhile to figure out how to “play”. In addition, the gameplay is simply incomparable to the experience of a AAA game like FIFA or CoD on an Xbox / PlayStation. From my perspective, Roblox as a gaming platform pales in comparison to other industry offerings.

But that conclusion is painted by my personal experience. It assumes the average user has the same options as I do, which is unlikely (most 10 year old’s don’t have ~$500 lying around to go buy an Xbox). In addition, it assumes that the value add for the core user aligns with my own desires, which is also incorrect (for example, the social component of the service).
These considerations point us in the right direction: as a result of its price (free / freemium), low friction / accessibility, and certain product features (UGC, identify / friends / social functions), Roblox has become hugely popular; it ended FY21 with nearly 50 million daily active users (DAU’s) globally, or nearly 4x higher than its user base at yearend FY18 (since Q2 FY20, the number of monthly payers has held at ~25% of total DAU’s).

This disconnect between my personal experience on the platform and the reported results is telling. It demands that we answer a seemingly straightforward question: what is Roblox? In my opinion, the answer is key to determining whether this business is worth investing in.

History
Roblox was founded in 2004 by David Baszucki and Erik Cassel (Baszucki, aka Builderman, is still CEO; Cassel passed away in 2013). The Roblox platform went live three years after the company’s founding (2007) and was added to iOS and Android in 2011 and 2014, respectively (as noted in the FY21 10-K, roughly 75% of platform usage is attributable to mobile). The company went public in March 2021 through a direct listing, with a reference valuation of ~$29 billion. The stock responded favorably to the massive tailwind experienced as a result of the pandemic, reaching ~$135 per share in November 2021; Mr. Market has since grown more fickle, with the stock closing Thursday at ~$42 (slightly below the March 2021 reference price).

As shown earlier, the platform took off over the past 2-3 years. Notably, this reflects success outside of the core geography / demographic (young kids in the U.S. and Europe). The company ended 2021 with ~25 million DAU’s in APAC and Rest of World (RoW), up from ~5 million at the end of 2018. In addition, the platform now has ~26 million DAU’s who are at least 13 years old, compared to ~6 million at the end of 2018. Continued growth among international and older users is critical to Roblox’s long-term vision of reaching one billion users. (That said, propensity to pay remains low in many international markets: when the S-1 was filed, the company noted that UCAN, which accounted for ~33% of DAU’s, was ~68% of bookings.)

(End of Preview)

For the full write-up, please subscribe to the TSOH Investment Research service.

post mediapost media
thescienceofhitting.com
TSOH Investment Research Service | The Science of Hitting | Substack
Long-term investment research with 100% transparency (prior disclosure of all portfolio changes). TSOH is written by Alex Morris, a former buyside equities analyst and CFA Charterholder. Click to read TSOH Investment Research Service, by The Science of Hitting, a Substack publication with tens of thousands of subscribers.
Reasonable Yield
@reasonableyield04/18/2022
Wow Roblox really took off after Covid hit (DAUs), has there been any evidence to suggest that things might wind down in terms of engagement post-covid, and any idea why UCAN DAUs have now declined from Q2 2020? Thanks!
+ 1 comment
The Science of Hitting's avatar
The Science of Hitting
$25.7MFollowers
@tsoh_investing04/13/2022
U.S. Digital Ad Market +35% in 2021
$GOOG, $FB, $SPOT

"Digital ad revenue in the U.S. jumped 35% to $189 billion... YoY growth was the highest the market had seen since '06... Advertising on digital audio - podcasts and streamed music / radio - grew faster than any other category, up 58% to $4.9 billion."

WSJ
Digital Ad Revenue Jumped 35% in the U.S. Last Year, Biggest Gain Since 2006
Advertising has followed shopping online during the pandemic at a breathless rate. The ad spend was concentrated—78.6%—at just 10 top digital publishers and platforms and the proportion is creeping higher.
The Science of Hitting's avatar
The Science of Hitting
$25.7MFollowers
@tsoh_investing04/11/2022
Ollie's: "Over Our Skis"
"The net result, as I see it, is as follows: Ollie’s became a messy story in late 2019, most notably due to lackluster 2019 comps and the passing of co-founder and CEO Mark Butler. Those concerns took a back seat in mid-2020, as pandemic-related headwinds led to a previously unimaginable improvement in comps, profit margins, and earnings. But now, as we look ahead to 2022, the core issue has resurfaced: Is Ollie’s a strong business that has the ability to >2x its U.S. footprint over the next 10-15 years, generating attractive incremental returns in the process, or are underlying issues putting the retailer’s long-term success into question?"

thescienceofhitting.com
Ollie's: "Over Our Skis"
In August 2020, closeout retailer Ollie’s reported a 43% increase in Q2 FY20 same store sales (SSS); to put that number in context, the company hadn’t reported a single quarter of double digit SSS growth since its IPO in July 2015. That result, which was reflective of a massive tailwind from U.S. government stimulus in response to the pandemic, was clearly unsustainable; as CEO John Swygert noted on the Q1 FY20 call (when it was already apparent that a strong Q2 FY20 was on the horizon for Ollie’s), “
The Science of Hitting's avatar
The Science of Hitting
$25.7MFollowers
@tsoh_investing04/10/2022
Ollie's Deep Dive + Update
I’ve removed the paywall on my Jan 2022 Ollie's deep dive (link below).

With the pandemic tailwind behind us and the stock down more than 50% from its 2020 highs, is now a good time to consider a long-term investment in the business?

TSOH subscribers will receive my updated thoughts tomorrow morning.

For access to all of my research, including philosophy discussions, deep dives, watchlist updates, and the disclosure of ALL portfolio changes before they’re implemented, please subscribe to the TSOH Investment Research service.

thescienceofhitting.com
Ollie's: "Good Stuff Cheap"
On July 29th, 1982, the first Ollie’s Bargain Outlet store opened in Mechanicsburg, Pennsylvania. The inspiration for Ollie’s was Building #19, a chain of discount stores throughout Massachusetts, New Hampshire and Rhode Island (Building #19 went bankrupt 2013, with founder Jerry Ellis saying, “We woke up one day and the world had outgrown us… our model was outdated”).
The Science of Hitting's avatar
The Science of Hitting
$25.7MFollowers
@tsoh_investing04/07/2022
Disruption & The "Right" Owners
“I met with our big institutional owners and asked if they would support flatter earnings growth... moving HBO faster to the global Netflix model. None of them thought the Turner networks could make that crossing... Our biggest shareholders didn't want us cutting our earnings.”

thescienceofhitting.com
Disruption & The "Right" Owners
In late 2021, WarnerMedia CEO Jason Kilar (who just announced his resignation) sat down for an interview with Peter Kafka of Recode Media. During the discussion, Kilar was asked about the views of former Time Warner CEO Jeff Bewkes, who has said he didn’t believe the company could’ve successfully pursued a global DTC SVOD strategy under his leadership; as a result, Bewkes says that he realized as early as 2014
Django Brooks
@django_brooks04/08/2022
Thanks for sharing! It’s truly so critical to be able to navigate and adapt to disruptions. And that Kilar quote was killer good!
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