Goldman Sachs sets the Netflix trap

The pump-and-dump is on.

Back when BitCoin and other cryptocurrencies were ascending to unprecedented and irrational highs, I churned out article after article detailing all the analysis from first principles why the real valuation of cryptos is zero, and not $20,000/BTC.

I started writing about the cryptocurrency bubble when BTC was hovering around $6,000/BTC, analyzing objectively with my background in technology and interest in market psychology and economics. I knew that when it started its meteoric rise, something just didn’t feel right.

When you’ve studied the patterns long enough and you’re familiar with the domain (software), you’re like a veteran chess player sensing danger in a position. You can take the time to fully calculate the end result to validate your senses, but you already knew instinctively that the position on the chess board will be won or lost in the long run.

BTC rose all the way to $20,000 rapidly and irrationally, and sure enough, BTC has plummeted back to that $6,000 level (which is still overvalued by roughly $6,000/BTC) as I had anticipated when I started sensing danger in cryptocurrency markets.  That is a 70% decline from its highs and counting.

To continue with the chess analogy, veteran chess players’ intuitions also kick in when the opponent sets a trap. Something doesn’t seem right to them when a well-practiced opponent suddenly makes an unusual move.

Goldman just set the trap today, raising its price targets to $490 for Netflix, without any real reason to do so. Like lambs to the slaughter, retail investors piled in because “top analysts” <sarcasm>who are just trying to be helpful to the common investor</sarcasm> told everyone Netflix is still a hot buy, making the stock fly on a day where Netflix hasn’t made any changes to its leveraged strategy, a strategy that will backfire immensely with the threat of rising interest rates.

Just like BTC during its irrational rise, I started writing objective analyses on Netflix, trying to bring sanity to what is truly an insane situation.

Article after article point out all the fundamental flaws in its business model and the ignorance of macroeconomics in its current market valuation.  My estimate for BTC’s value is close to $0 (but not exactly $0). NFLX on the other hand at least produces something not easily replicable, so while it may not be valued close to $0, I concede it is worth something, just something more reasonable than $490/share. In a sane market where cheap loans are not in abundance, its value is close to $40-80 (for a price-to-earnings ratio in a more reasonable 5-20 range).

Just like when the media piled on to get all the suckers to buy BTC at $20,000, that same fishy behaviour is prevalent again, with Goldman Sachs’ price target announcement on the eve of potential rate hikes. The mere fact that the price target adjustment is attributed to Netflix being “on track” to reverse its negative cash flow, a statement backed by nothing but pure speculation, it is huge warning sign.

“While the widening gap between Netflix’s growing income statement profits and the increasing cash flow statement deficit has seemingly had little impact on the company’s valuation, we do believe that as the gap begins to reverse and Netflix’s cash flow inflects positively in the coming years, NFLX shares should benefit,” Terry wrote.

The thing about passively consumed content that Netflix specializes in, is that it becomes stale very quickly. People will generally watch shows and movies just once, and after that, a production’s profit potential has already been saturated.

Take Hollywood movies as a practical example. How many big-budget films are still raking in millions of dollars on a regular basis after release?  Close to zero. Box office receipts are important figures because once the hype and the freshness of a film dies down, the production shouldn’t expect to make any more money, at least on the same scale as it does at initial release. The box office numbers a couple of months after release dictate the success of the film.

Other than building a name for franchises and series, Netflix’s current negative balance sheet tells a story of its original content becoming stale, exhausting its potential to increase future earnings, with zero immediate profits for their efforts.  During the most important time to recoup the costs of production, Netflix has been deep in the red with its productions. I wouldn’t expect any significant future earnings potential from stale TV series and movies. The costs have been sunk, and only cheap debt and speculative investors have been giving them a lifeline to continue their poor business model to continue to make original productions at a net loss.

History tells us that when big-budget films flop and don’t churn out a reliable profit, they won’t see a reproduction. Yet Netflix is reproducing its content at a high price tag with the expectation of future profits. It simply doesn’t make sense given the content it produces. Your favourite Netflix series may be cool now, but no one is going to care about it when the next fad comes along.

Just because subscribers are currently joining en masse, it doesn’t mean they are willing to negotiate Netflix’s debt for all the near-free original content they consumed in the past. Their current subscription fee may cover the costs of upcoming content, but that heaping pile of debt from past productions are unlikely to be paid off, and will become even a bigger burden if the cost of maintaining that debt rises in the near future.

This logical analysis is conveniently ignored by Goldman’s price target increase. With Netflix’s downward trend on its balance sheet and macroeconomic factors putting added pressure on the debt, Goldman Sachs isn’t trying to educate the masses with analysis from first principles, rather it is doing what it does best: manipulate the market to increase the value of its own positions, only to dump it all on the suckers that buy into bubble.

I’m sensing a lot of danger in this stock the same way I recently felt when Bitcoin irrationally marched past $10,000/BTC.

Welcome to $20,000 Bitcoin all over again.

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