Warner Bros. Discovery: A Streaming Giant In The Making

The full article is available on Seeking Alpha. This is just a preview. I’ve written about Discovery in the past. Here are the previous posts if you are catching up Part IIIIIIIVVVI.

Summary

  • A conservative valuation points to some upside.
  • This is an investment for the patient investor.
  • Do not underestimate the creator of the 90 Day Fiancé.
  • WarnerMedia and Discovery have some of the best assets in its class.
  • The future company will be a juggernaut in the DTC streaming space.

I bought Discovery Inc. (NASDAQ:DISCA) back on March 29 at $41.50 following the Archegos meltdown. For a stock that was once trading at $77 back in March, it felt like I was getting a bargain. When somebody, in this case Archegos, is dumping shares of a good company at bargain prices, I’m a buyer. When somebody is in a desperate situation, and needs to sell, the buyer is in a good position. I’ve been following the company for years and an opportunity presented itself. There was “blood on the street” as we say and I moved in. But short-term noise took over the narrative. DISCA fell, and fell, came back for a bit, and then fell off a cliff. At this moment DISCA is trading around $25 despite being a good company.

Chart: DISCA 2021 YTD Performance

Discovery is my worst investment in a long time. Of course nobody bats 1.000. They can’t all be winners. I bought companies in the past that fell 10% after I bought them. It happens and it mostly works out. DISCA sticks out like a sore thumb. I’m down 38% in almost seven months. Simple arithmetic says that’s a big hole to come back from. Losing money hurts. It double hurts when everything else I could have bought is going up. It triple hurts when you are public about the purchase (previously documented on the blog). You don’t want people to lose money. But again let me reiterate that this is not investment advice and you should do your own research.

The languishing stock price warrants some reviewing. Why is it that I do my best research after a stock is down a lot? I need to ask questions and to be honest with myself. Was this a mistake? Am I trying to make the story work? If so, when is the story going to work? Do I sell? If this is truly a bargain, should I buy more? If I liked it at $41, wouldn’t I love it at $25?

What do investors see?

I can’t predict the future, but I can try predicting the present. So what do investors see?

  • The turning point seems to be the WarnerMedia merger. After the Archegos selloff, DISCA bounced back near my break-even point of $41.50. But following the merger announcement, the market reacted negatively. A lot of debt, deal complexity, and uncertainty clouds the story.
  • DISCA is getting kicked around. Sentiment is negative. Sometimes the reason for a lower stock price is a low stock price.
  • A complex deal to buy WarnerMedia weighs heavily. We still don’t know how it’s going to be structured. Is the Reverse Morris trust structure going to be a dividend or an exchange offer for AT&T holders? Details remain scarce.
  • We don’t know how the streaming services will be rolled out and priced. Well they know but won’t tell us. This is a nightmare if you are a Wall-Street analyst that needs key numbers to plug in the financial model.
  • Discovery has three classes of shares trading at three different levels. It’s not efficient.
  • The overhang from AT&T shareholders selling post the deal close. Most T shareholders are in for the dividend. Warner Bros. Discovery (Newco) won’t distribute a dividend.
  • Cable TV is bleeding subscribers. There’s a lot of FCF in that segment but there’s no growth and Wall-Street cares about growth.
  • A crowded streaming space that’s getting more crowded. Growth in streaming is slowing.
  • The deal won’t close until mid-2022 or later, if they get the regulatory green light. That’s another ~nine months? That’s an eternity for today’s investment timeframe.
  • Warner Bros. Discovery will have a lot of debt, ~$55b.
  • HBO is the best, but they have made missteps under AT&T ownership.
  • Some are doubtful that Discovery can achieve $3b a year in synergies. That’s a big number. That’s $30b in value at 10x multiple. Great if they achieve it but remains to be seen.

Purgatory

Combine all of this and you have dead money. This means DISCA won’t likely significantly move until we have better visibility, more certainty on the deal. However, having said that, I had success with stocks in “purgatory”. It’s the place stocks go when they fall out of an orbit. They are in the “nobody cares about them” bucket. They stay in that zone for a while until some event push brings them back. This is where Discovery is. You can value Discovery as a stand-alone business, but we lack crucial details on the merging entity. A stock in “purgatory” can present an opportunity. It’s an uncrowded fishing pond. This means you can take advantage of this opportunity to build a position. If you have an investment horizon a little longer than the average investor you can do well in that space.

The full article is available on Seeking Alpha.

What’s Next For Apple and Tim Cook

The Original Apple Logo. That’s Isaac Newton.

Tim Cook has juste celebrated his 10 year tenure at the helm of Apple. Under his reign Apple’s market cap went from $350 billion to $2.4 trillion. No other CEO has created more absolute value for shareholders. Sales went from $108b to $274b in 2020. Net profit went from $26b to $57b.

Before him Apple was being run by co-founder Steve Jobs. Not the smallest shoes to fill. Do you remember what was being said back then? Steve Jobs was Apple. Steve Jobs was the guy behind the 2nd coming of Apple. Steve Jobs was behind some of the most iconic innovation in consumer electronics. Steve Jobs was one of the greatest business man ever. Steve Jobs was celebrated. Steve Jobs was bigger than life.

So who’s Tim Cook? The supply chain guy? Not exactly the profile you look for when trying to inspire employees to create “insanely great” products. The Apple fanboys weren’t thrilled and worried that the company was destined to decline.

After ten year, Tim Cook can look back with satisfaction. Tim Cook has created more value than Steve Jobs. The question now is who is worthy enough to replace Tim Cook when he’s done? Who can take a $2.4t company to the next level? I’m sure they are looking at the supply chain employee list.

Tim has maintained Apple’s record of innovation and its brand. He took Steve Job’s creation and made it better and bigger. This is definitely a business school case study. This is the greatest business transition of all time.

Under Tim Cook, Apple exploited four trends:

  1. Global supply chain – it has built an immense production network with China at the center.
  2. Chinese consumers – $60b in sales, 5x what it was ten years ago. China loves Apple and Apple loves China.
  3. Government were lax about tech giants with high market share – 60% revenue market share in America and a dominant position in OSs. Just look at the nice billions ($8b-$12b annually) it gets from Google in return for making it the iPhone’s search engine.
  4. Low taxes – Thanks in part to legal structure using tax havens, Apple’s tax rate was around 17%

However these four trends are becoming less favorable.

  1. Geopolitical tensions threaten global supply chains.
  2. China under President Xi Jinping is becoming more unpredictable. His policies makes it less attractive to rely on Chinese consumers for 19% of sales.
  3. Governments around the world are targeting big tech. Big tech are easy targets for regulators and politicians.
  4. The tax bill is going up. A deal brokered by the OECD may gradually forcer multinationals to pay more tax.

The next ten years won’t be easy for Apple and Tim Cook. What’s the plan? Apple will continue to shift towards being a subscriber-based firm. It has over 1 billion users who enjoy an array of services (21% of sales). They have one of the most beloved brands. In a toxic digital world, people can trust Apple. Apple is still about beautiful designs and high-quality manufacturing. They will continue to advance and push innovation. The iPhone 13 looks promising (50x faster than the iPhone 4, first iPhone under Cook). They are also pushing deeper into health, news, entertainment, music, gaming and services. And it will continue to try to invent a new generation of hardware. The rumor of a iCar or iGlasses pops up from time to time. Apple is looking into pushing deeper into search.

Apple is also shifting part of their supply chain to America. Long-term assets have risen to 70%, from 38% when Cook started as CEO. I’m sure he’s looking at plans to pivot away from China in case things go sideway. But I think the company has navigated its relationship with China well so far. China is a large market for its product and services, but also Apple creates significant employment in China.

Tim Cook was a big believer in the App Store (Job was ambivalent). Cook understood the importance of network effects. He understood the economic mechanism in digital markets which makes big businesses even bigger. Cook pushed hard on the digital “flywheel”: the App Store attracts more app makers, which attracts more users, which attracts more developers and so on. Today there’s nearly 2m apps, which facilitate $643b in billings. Apple takes a big bite of that.

iPhone 13

A short comment on the new iPhone 13. Every announcement is predictable. There’s no surprises. Every iPhone announced isn’t a huge step up from the previous one. But little incremental improvements, consistently, for a long time is a recipe for success. A faster processor, a better camera, a better battery, higher memory capacity, and more expensive.

I’ve no clue how many they will sell, but I’m sure it will be a lot. There’s a fight among analysts that are trying nail exactly how many people will buy and upgrade their phones. There’s over 50 analysts covering Apple and many more on Seeking Alpha. I don’t have a particular insights. People are looking at wait time on the Apple website for demand signal, or supply constraint. I’m not that guy. All I can say is I’m invested in Apple for more than just a phone cycle and that has worked well.

Summary

There’s no doubt that the next ten years will be tougher than the first ten. How do you keep growing? How do you keep these fat 40% gross margins? The App Store commission are trending downward.

But who would have though that Apple would have been a $2.4t company ten years under Cook? Even $1 trillion was a massive milestone. The Apple today is a better version of the pre-Cook Apple. Tim Cook is likely to stick around until 2025 when his current stock grant fully vest (but I doubt it’s about the money).

Disclosure: Long AAPL

Emerging Domestic Markets

Columbia University Press sent me a copy of Emerging Domestic Markets by Gregory Fairchild to review. Dr. Gregory B. Fairchild is the Isidore Horween Research Professor of Business Administration.

I know you are not supposed to judge a book by its cover, but the title “Emerging Domestic Markets” grabbed me. It’s a strong title. The under-title is “How Financial Entrepreneurs Reach Underserved Communities in the United States”. Even though the book is focused on the US, the lessons can also apply elsewhere. Before getting into the review, I want to do a detour. 

In this review I’ve drawn from my personal and professional experiences. A younger me worked for a private equity fund in frontier markets (pre-emerging markets). I’ve seen poverty and what can be done to fight it. I’ve seen wealth creation in action. We have solutions. 

I’ve been back in Canada for a few years. Because I’m now domesticated (wife, house, kids, Netflix), I look around and wonder what can be done to improve the community. Canada is not considered a poor country. It’s a wealthy, rich country. I’m very fortunate to be here. People want to be here.

I live in a good area. But there are pockets of poverty. There’s poverty ten minutes from here. There are kids that don’t have three meals a day. There are schools in terrible shape. Montreal, Toronto, and Vancouver have growing homeless problems (in contrast it’s very rare you will see a homeless person in “poor” Vietnam). The hardship is real. A lot more than we acknowledge.

Philanthropists like to point out the new school in Africa they built. It’s a great gesture. But you don’t need to go this far to help out. We could use, and I apologized for the over-used political term, some “nation building” at home. Or maybe community building is a better term. We can do better.

Part of the problem is that we first need to acknowledge that there’s poverty. Of course we are not blind. We know it’s there, that it exists. But we need to change our perspective. 

Here’s a perspective problem. A friend started a company in a frontier market. If you use their coupon app you get free bandwidth. I asked him “why don’t you do this here, we have poor people, and bandwidth is expensive”, his answer was “true, but here people don’t think they are poor”. If you don’t think you have a problem, how are you going to address it?

We can’t ignore poverty. It affects everybody. You can ignore the problem, but eventually the problem won’t ignore you. Look at the homeless problem in LA. It would have been easier to address it ten years ago. Now it seems unsurmountable.

The proliferation of severely distressed areas is a drag on the health of our economy. Where economic growth falters in one area, it has an impact on us as a whole. Low-income communities present viable, untapped opportunities. Future economic growth requires investment in markets historically overlooked by mainstream financial institutions. 

The Book

Here’s the review:

I read “Emerging Domestic Markets” with great interest. Part of it is personal, maybe selfish. I’ve long thought about ways to ameliorate the issues before us. Not just writing a cheque and calling it a day. I’m referring to sustainable wealth creation. Breaking the cycle of poverty. Improving society.

The book “Emerging Domestic Markets” embodies some of my personal thoughts, that we shouldn’t overlook domestic markets. Even though the book is US centric, there’s poverty everywhere and the book provides insights on how to tackle it. 

“Emerging market” refers to a country where incomes are currently low but that is likely to experience rapid growth increasing economic competitiveness. But Dr. Fairchild takes a closer look at home. Many of the characteristics of emerging markets are also found in the US, or here in Canada, in communities that have been underserved by the existing financial-services system. 

The book has fourteen chapters that address a variety of topics.They range from financial services in low income areas like Chicago’s south side, lending to a latino family in LA, to private equity among other topics. Each chapter is a standalone. But like most books it makes more sense to read from beginning to the end.

Each chapter follows a similar structure: A backstory, some history, a question, followed by a study or a facts-on-the-ground mission, and what the findings tell us. The boots on the ground approach gives you a confirmation about things you understand but do not fully know until you see and experience them. Dr. Fairchild also includes his own experiences as a consumer of financial services and products.

The book asks questions such as “If capital flows to the lowest-risk, highest-return environment, how do we attract investments in distressed areas? How do we get financial institutions to serve or lend in high-risk, low income areas?” Can they do so without imprudent levels of associated risks? The book collects findings from years of quantitative and qualitative research. 

I think the thing that makes the book stand out is that it’s not another academic paper saying “do this and that to solve the problem”. The book is real stories on what worked and what didn’t. There’s a good wealth of knowledge across different subjects. I find that more powerful. 

The book doesn’t claim to be the authority on solving societal ills. If anything, it’s a good starting point to open the discussion and raise awareness.

There’s divergent views on how to address poverty. There’s no single formula. Dr. Fairchild asks questions on a subject, observe, and report. Our systems are complex; they call for cross-sector, multiple actor, and institutional solutions (multiplex prescriptions). Education is part of the solution. Business is part of the solution to repairing the economy and the social fabric. 

Entrepreneurship is a big part of the solution. But you need to create value by connecting them with capital, assisting them with advice, and guiding their growth. You need an ecosystem to support that, like more accessible financial service. You also need more community development such as affordable housing, early childhood centers, health care centers, and even after-school programs. 

Income inequality as a matter of education inequality. If lower-income families are on the sidelines, inequality is not declining, it’s increasing. It starts with education. One simple solution, that everybody can do, from rich to poor, is educate people about financial services products and how to manage them. When I was a kid, an employee from the local credit union would come to school and collect weekly deposits (I contributed $2 every week). We had a bank booklet that we needed to balance. We had interest (it was a thing back then) on our deposits. I remember the interests compounding. I didn’t become rich off this. But I was considered “banked” and I was able to build off that knowledge. I don’t think they do this anymore. Something about not being allowed to sell to kids. But we can still educate them. 

One of the themes of the book is that the environment in which we live has considerable and long-standing influence on our economic outcomes. If we can improve that environment, we all benefit.

The one thing that the author might have overlooked but he also acknowledged is the importance of technology. The role of technology is important. Permanently divorcing physical location from economic opportunity gives us a real shot at expanding the number of good jobs in the world while also dramatically improving quality of life for millions, or billions, of people. We may, at long last, shatter the geographic lottery, opening up opportunities to countless people who weren’t lucky enough to be born in the right place.

I like the book. I will go back to it. It has a space on my shelf. Buy the book. Get involved. Raise awareness. Get something done. Just do it. Let’s create capital, jobs and wealth in our local emerging market.

Buy the book here or on Amazon.

Canadian Elections

There’s an election on the horizon. An unnecessary one. But important one. Because whoever wins will get to decide the post-Covid world we live in.

The Liberals won their re-election bid two years ago and still have two years left on their current mandate. So why call this unnecessary election?

The Liberals are saying a new mandate was needed to steer the nation out of the pandemic. Nobody is buying that. That’s a b.s. answer that’s hard to peddle. Basically if you must explain, don’t.

The truth is simpler. It’s classic politics 101: Never get a good opportunity go to waste. The opportunity? To take advantage of a very weak opposition. Well do the Liberals even have an opposition? Sure you have an “anybody but Trudeau” bloc of voters, but is there an opposition that’s respectable enough to earn your vote? Please give me a good reason to vote for you other than “not Justin Trudeau”. The Liberals wagered that a grateful electorate emerging from lockdown would reward their minority Liberal government with a majority. The Liberals have an opportunity to cash in on their Covid “goodwill” (aka you get a check, and you get a check, a la Oprah) before fatigue sets in and people ask for change. Take note that since I started writing this post, the polls between between the Liberals and Conservatives have tighten and are basically neck to neck.

Nobody wants this election right now. The voter’s state of mind is not there right. We are sending our kids back to school, people are returning to the office, or not, the delta variant is raging, and “mu” is the new variant on the street (why such a cute name for killer?). Or maybe the Liberals were banking on low voter turnout?

This is not a pro any-party post. I’m not endorsing or am affiliated with any political party. I don’t ”box” myself in a party. I don’t do the left wing, right wing thing. I try to stick to what works. If I had to describe my political leaning, it would be fiscally conservative (balance the budget), socially liberal (go ahead be gay and marry you dog, not my business), with a sprinkle of libertarianism (less government babysitting). But that’s not a way to vote. Nobody ever gets everything they want. Politics is the art of comprise. So, for any politician reading this, my vote is for the taking. Please give me a good reason to vote for you.

Democracy

I will vote. I don’t want too but I will. It’s my duty as a citizen in a democracy. People before me have sacrificed. I have a voice, so might as well use it before I don’t have it anymore. If there’s a perfect system of politics, the world hasn’t seen it yet. But one thing’s for damn sure: democracy is better than anything else out there. Democracy is fragile. It can easily be lost. Democracy is messy and frustrating. But it’s better than anything else out there.

The grass might look greener elsewhere, but it’s not. Other countries look at our grass (or snow) and thinks it’s greener (or whiter). If you are not satisfied with the people in office, you voted them out.

Continue reading “Canadian Elections”

Afghanistan – No Victory Parade

I remember 9-11 like it happened yesterday. I remember the build up to the war. I remember the support for the invasion of Afghanistan at around 90%. I remember former President Bush’s words “You are with us or against us”. The U.S. had global support. Somebody had to pay for these terrorist attacks. It was payback time. Here are the evil guys, let’s smoke them.

After 20 years, four Presidents, two Democrats and two Republicans, $2.26+ trillion, thousands of lives lost, this is a massive colossal foreign policy failure. It took ten days for the Taliban to take over the country. The Taliban just walked into Kabul over the weekend and took it.

An national Afghan army of 300,000+ folded like a house of cards. They didn’t even put up a fight. No resistance. They have been trained by the best. They had the best equipment. Why did it fail?

The short answer: They were rotten from the inside. 

The writing was on the wall. The Taliban was going to take over the country. It was a question of time. The CIA was optimistic. They estimated that it was going to take six months for the Taliban. Where everyone was wrong, is how easy it was going to be. In contrast, it took the mujahedeen three years to push-out the Soviet backed puppet government after they left.

Americans were tired of this forever war in Afghanistan. Americans wanted to get out for a long time. Americans don’t think about Afghanistan on a daily basis. And frankly, they don’t care about Afghanistan. Everybody wanted to get out. 

So why the uproar? 

It’s the graphic images of failure. The visuals are engraved in your mind. People falling to their death from American planes bolting out of the country. Staff at the embassy burning sensitive documents. Officials racing to destroy military equipment and hard drives containing classified information. An Afghan President fleeing abroad,  leaving the government in collapse. This not how victory smells.

This is not how the final chapter to the 9-11 attacks was supposed to go down. Americans play the hero. Bad guys don’t get to party at the end. You are supposed to hear “hooray”, not chanting “Death to America”. What now? A big victory parade to celebrate?

This is not what the Afghan deserves, the people that lost their lives, the people that fought for a better place.

Secretary of State Anthony Blinken said ‘that is not Saigon’. He’s right. It’s Saigon on steroids. It’s hurt to see Biden and the Democrats trying to spin this off as a success. Stop. Take the loss. Learn your lessons. Move on. Stop trying to fix unfixable countries. Fix the U.S. I’m sure it could make a better use of $2 trillion.

Graveyard

Afghanistan was destined to be a failure. It’s a graveyard of empires. The Americans followed the footsteps of Alexander the Great, the British, and the Soviet Union. Years ago the Taliban reportedly said ‘You have the watches. We have the time’. The Taliban were prepared to wait out the West. It was prophetic. 

If you look at pictures of Afghanistan, and you see this mountainous broken terrain, the terrible weather, people living in tribes, you wonder how the hell does anyone control this place? You don’t. 

Let’s me ask these questions:

Going in, nobody knew it was going to be a twenty war with no end in sight. Knowing that, would we have still gone in? Knowing it would have cost $2.26 trillion, thousands of lives lost, the millions of people displaced, would we have still invaded?

Blame Game

Everybody is playing the blame game. It’s Trump or Biden’s fault. On paper Biden will take blame for this because the failure falls under his watch. The truth is that he inherited a series of bad decisions and missteps made over twenty years. Obama wanted to get out. Trump wanted to get out. Biden was telling Obama to get out when he was VP. Now Biden pulled the plug. What’s the alternative? Another trillion? 5 more years? Pass it on to the next President? Americans didn’t have the stomach for fighting anymore.

No Plan

Twenty years. The U.S. never had a clear plan for the future. They didn’t have clear goals. The U.S. had twenty 1-year plan. After clearing al Qaeda out, what was the plan? What were they doing? What’s the end game? How do you measure success?

The Taliban can thank the U.S. taxpayers for the new state of the art military equipment, Humvees and their new air force. The Taliban was fighting with stuff from the 80s provided by the CIA. So I’m sure the refreshment is welcome. Seeing the pictures of Taliban fighters testing the new equipment would make the NRA proud.

Taliban 2.0?

Infamous for its brutal executions and oppression of dissenters and women, and anyone who fell afoul of its ultraconservative rules, the Taliban claims that women will have rights “within the framework of Islam”. The press will have rights. The opposition will have rights. Amnesty for government officials. Nobody will be harmed. Did the Taliban turn “woke”? Well the Taliban is on Twitter (sort of hilarious considering Trump can’t) and maybe they don’t want to be “canceled” by the social justice warriors.

The new Taliban regime has a good PR machine. They are saying the right things. They know the world is watching.  They understand politics. Of course I’m skeptical. So is everyone. I’m not drinking one oz of that kool aid. 

Sharia law is the law. “Within the framework of Islam” is a vague parameter given the extreme interpretation of the religion that the group is known for. So don’t expect a women’s march downtown Kabul. 

Lessons

This is a classic case of hubris. Stop attempting to refashion countries into a pro-Western democracy. It’s better to stay out of other people’s business until they have a very clear and good plan.

Many are weighing in over whether America’s longest war was worth it – as well as the pace of the withdrawal or future threats – that debate will continue for some time and will be one for the history books.

Inflation-Hedging Investments

The question I frequently get lately is “inflation is here, what should I invest in?” Given record levels of monetary policy stimulus, central bank plans to let inflation run hot, and rising fiscal deficits, it’s a good question. Since we can’t hide from it there are things you can do to minimize its impact.

We are witnessing strong levels of inflation in categories such as labor, logistics and raw materials. Some of it we see everyday, like in food, gas, and lumber. There’s also the inflation we don’t see, like the cost of a shipping container that’s about 10 times what it was a year ago (and good luck finding one). 

First I want to address the financial headline that’s making the round: Consumer prices continued to surge in June, up 5.4%, rising at the fastest pace since August 2008 and raising fresh questions over whether price inflation will be transitory. This rate more than doubles the Federal Reserve’s 2% annual inflation target. Ok, the number is “breaking news” but it was highly expected and that’s why the markets didn’t react much to the “shocking” headline. And once you dig a little bit you realize the number is highly distorted. 

Some of the hot inflation readings in recent months have largely been attributed to the so-called base effect, where depressed pandemic levels from a year ago translate to artificially higher year-over-year rates. The latest CPI reading is a measure of the June 2021 number over the June 2020 number. But in June 2020 the country was still deep in the pandemic trough. It’s akin to taking a hot bun out of the oven and comparing it to a frozen one. Eventually the base effect will disappear and in another few months we will have more accurate readings.The point that headlines can be misleading. Either way, your grocery cart is costing more and that doesn’t make anybody feel better.

Back to the opening question. I wish there was a simple answer, a simple solution. As easy as asking your pharmacist for an ointment cream. “You have this symptom, take this and it will be gone.” The truth is that investing is not easy, despite the impression the TV people and the Reddit crowd gives. If it was easy, we would all be rich. And I wouldn’t be getting that question so many times.

Here’s what we are dealing with: Inflation: 5.4%, 10-year bond yields: 1.4%, Gold: flat over the last year, Bitcoin: 50% off its high. I’m mentioning Bitcoin and gold because they are both considered inflation hedges. As for Bitcoin, the narrative is constantly changing.

My point is that inflation hedging is not as easy as it sounds. So I decided to throw together a post to summarize my thinking on how to approach inflation. Please note that I’m not a pharmacist so my answer is more complex. 

I split the post in two parts. The first part is a short 101 primer on inflation and interest rates. It helps to understand the relation between the two. The second part touches on the investment approach. Feel free to jump around.

Continue reading “Inflation-Hedging Investments”

Amazon – MGM deal

Soon property of Amazon if regulators approve

When analyzing the WarnerMedia-Discovery deal, the Amazon-MGM deal came the week after. I was wondering what this meant for the WarnerMedia-Discovery deal? (Disclosure: long DISCA.) Want to read more about the Discovery-AT&T deal? Start here Part I, II, III, IV.

I was looking at what Amazon got for the $8.5 billion they spent for Metro-Goldwyn-Mayer Studios (MGM). Except for the James Bond franchise, I can’t really say it’s a collection of trophy assets. Sure they have some good second-tier franchises like Tomb Raiders, Rocky (a personal favorite), The Handmaid’s Tale, and Real Housewives. MGM has a catalog of more than 4,000 movies and 17,000 TV episodes. But how much would you pay for a MGM+ subscription? Not much. Their classic stuff was sold a long time ago during the Ted Turner era when he owned MGM. Turner sold the studio, while keeping the rights to many of its historic movies, which are now owned by WarnerMedia and available on HBO Max.

Under the quality of content approach, the WarnerMedia-Discovery merger looks cheap. WarnerMedia has arguably the best content library. HBO Max is first class. It has the Sopranos, Game of Thrones, the D.C. comics universe, the Matrix, Dunes, Harry Potter among others. Disney bought Star Wars in 2012 for $4. Disney also paid Marvel for $4b in 2009. The Marvel deal was considered a little crazy at the time. Prior to the Disney deal, Marvel sold the Spider-Man rights to Sony and X-Men to Fox. “No Spider-Man and X-Men!? Who cares about the rest of Marvel?” Well Disney bought Fox’s media assets for $70b and fixed the X-Men problem. As for the Spider-Man problem, Disney and Sony struck a deal. As for the rest of the Marvel Cinematic Universe (MCU), Disney took the IP and made something out of it. For example, under Disney’s wing, the MCU took more risks and explored other, less popular characters from Marvel Comics that ended up being a big hit, like Guardians of the Galaxy. Thanks to the MCU, Marvel is now one of the biggest names in film and comics. I’m sure Warner Bros. Discovery and Amazon/MGM to turbo charge IP development.

Think Like Amazon

This is not a classic media deal. It’s hard to see immediate benefits or logic.  But we are talking about Amazon here. You have to think outside the box. What does Amazon do? They think long-term. They start with the customer and work backward. They invest and experiment a lot. A lot of their CAPEX won’t provide a return for years. They have a flywheel business model (lower price => more customers visit => increased the volume of sales => more commission-paying 3rd-party sellers => to get more out of fixed costs like the fulfillment centers and the servers => this greater efficiency then enabled it to lower prices further = accelerate feedback loop…you get the idea). They have AWS that subsidize every other part of the business. So when analyzing this deal, try to look at it from Amazon’s perspective. 

First the money. Analysts and media think Amazon overpaid. Yes it is a lot of money for most media companies. But Amazon is not most companies. Again you need to look at it from Amazon’s point of view and how it fits in their business model. Amazon has a market cap of $2 trillion, so $8.5 billion is their pocket change. Amazon will eventually remove the content from other platforms once the license expires and lose ~$1.5b in annual revenues, a rounding error for Amazon. 

This is not a move to boost next quarter’s numbers. The short-term reason is to expand their video library. Prime Video is okay and getting better. This deal improves its position. It’s one of the goodies that comes with your Prime membership (which you get for free shipping). An improved Prime video can lead to a boost in membership and membership price. Amazon’s subscription services generated $25.2 billion in revenue in 2020, representing 7% of total revenue. 

The long-term reason is strategic. You are setting up the pieces on the chessboard. There’s a streaming war and the players are rushing to build their arsenal. Disney, Netflix, and NBCUniversal (Peacock) all want to become global streaming champions. CBS (Paramount+) is looking in. Amazon is muscling in. Apple has money and ambitions. To play you need the scale and resources necessary to compete. The players are buying content and removing it from each other’s platform. Basically the move is to get the IP and lock it up. In the process companies are passing up a big paycheck. By locking out the content, and making licensed content more scarce, you are increasing the value of all the other stuff out there. You have more dollars chasing more scarcity. Well in theory, but I know there’s more to it. By paying this much, you are creating a floor on the value of content.

Amazon has Fire, their streaming video distributors, like Roku and Apple TV. These platforms have achieved scale by bundling together the growing number of streaming video services into a convenient user interface. And aside from selling the hardware, they are generating recurring revenue by selling monthly subscriptions to premium video channels, and they are even creating their own ad-supported “channels” from licensed content (e.g. The Roku Channel). If the platform provider can capture a large enough global scale of consumers who are using it as a bundling agent, then they can exert some degree of leverage over the suppliers of the content (e.g., to gain a pricing advantage or some other access differentiation).

This is not just about television (or streaming to be more accurate). This is about taking IP and bringing it to the next level. It’s more than just a one way street. You need to leverage the IP in many different ways. You have to think about video games (Amazon has a game studio), Kindle/books, podcasts, music, licensing, merchandise, toys etc…Disney is the best at this. It would be stupid not to think that Amazon doesn’t have a plan to shake up some of the more sleepy assets. The real financial value behind this deal is the treasure trove of IP in the deep catalog that Amazon plans to reimagine and develop.

Competition for consumer attention is at an all-time high – including a wealth of well-capitalized video services, social platforms, audio networks and gaming services – with massive audiences and robust mobile engagement. This is the new galaxy in which the contemporary consumer finds himself.

WarnerMedia-Discovery
The WarnerMedia-Discovery deal is expected to close in mid-2022. Analysts are divided on the prospects for the deal. And by looking at the share price investors are not confident.  I think the combination is a compelling long-term opportunity. The combined assets offer a compelling direct-to-consumer offering. In terms of valuation, Discovery, trading 7.1x EV/EBITDA, trades at a significant discount to its peers. CBSViacom trades at 9x, Netflix at 54.4x, MGM at 39x, LionGates at 25x EV/EBITDA. At current levels, purchasing Discovery stock seems to provide an inexpensive entry point for playing the creation of Warner Bros. Discovery. If we assume pro-forma EBITDA of $12.3b, and a 10x multiple, there’s a 23% upside to Discovery. 


In the long-term, to win the streaming war, I expect more consolidation down the road.

The Three Body Problem

I read The Three-Body Problem by Cixin Liu, originally written in Chinese and translated by Ken Liu.

And where do I start?

I think former President Obama nailed it with the blurb in the back of the book: “Wildly imaginative”. This is not a political endorsement or anything like that. I don’t put much weight on book blurb but these two words like I said, nailed it and should complete the post. The rest of is side dish.

Since I can’t use “wildly imaginative”, I found it eye opening. Surprising. Out there. Unusual.

Ken Liu did a excellent job translating it. Ken is also a legit accomplished sci-fi author himself. I’ve read acclaimed foreign work in the past and the translation can be clunky. I appreciated the English version of Metro 2033 (Russian), it felt that some of the original flow was lost in translation. I had the same feeling when I read bestseller Gomorrah by Roberto Saviano.

It was also very interesting to dive into Chinese culture and history. I had to google stuff about the cultural revolution to get fill in.

The book has been recommended in the past. And after seeing it on a few list, why not give it a shot. I was looking for something different and it delivered.

What is it about? Because this book is so out there (in a great way), I find it hard to talk about without ruining it. Or to even make sense. You just have to pick it up and go for the ride.

The Three-Body Problem is a complex work. It’s a blend of physics, science, astronomy, and technology with a dose a philosophy. Put all that stuff in the blender and you get a Hugo Award-winning.

This is the first book of a trilogy. I think it was setup that way because the first book doesn’t end. So I will need to read the second and third book. The body of work is over 1,200 pages. The trilogy have now sold more than nine million copies.

Netflix announced that Game of Thrones co-creators David Benioff will adapt Liu’s award-winning trilogy. I look forward to see how to adopt such a complex work. They already did a stellar job with the fantasy stuff, let’s see how they do with sci-fi.

Chinese sci-fi certainly seems to be having its moment in the spotlight. It’s definitely attracting Western attention.

The Wandering Earth, a collection of shorts by Liu Cixin, was adopted as a movie. Apparently it was the third highest grossing film of 2019, behind only Marvel Studios and Disney’s “Endgame” and “Captain Marvel” and nobody noticed. $700m of that was in China, so maybe that’s why. The movie was on Netflix, so I checked it out with English subtitle. The special effects are on par with anything Hollywood produce. However the script, or the subtitle in my case, was pretty bad. It reminded me of some corny action movie from the 90s. So watch it for the graphic.

Worker Shortage, Inflation, Rates, Biden-Putin

Worker Shortage

Job openings soared to a record 9.3 million in April as the economy reopened but 3.5 million Americans are still on weekly jobless benefits and more than 9 million remain unemployed. The economy is still 7.6 million jobs short of pre-pandemic levels.

The numbers are very contradictory. This means the U.S. is experiencing high unemployment at the same time as a labor shortage. There are many reasons for the hiring scarcity like shifting employment choices, programs such as enhanced unemployment benefits, lingering COVID-19 worries, unqualified labor, and the need to raise wages. The last job report indicated that wages are rising. 

I didn’t look up the numbers for Canada but I’m sure we are in a similar situation. A quick tour around town shows a number of restaurants, small businesses that have restricted their hours, that aren’t serving lunch, or aren’t open at all because of the workforce shortage.

The solution is a set of policies to help train more people for in-demand jobs, remove barriers to work, and attract legal immigrants. Also we need new efforts to connect employers to undiscovered talent.

Inflation

Inflation is the big word on the block. I don’t need to remind you that prices are rising everywhere. The main question is will it stabilize, go higher, or go away? The answer to that will help determine the direction of interest rates.

There are different schools of thought on the topic of inflation. On one side, you have the Fed saying that inflation is “transitory”. The source of inflation is supply related. Solve the supply shock and you solve inflation. There is some truth to that. Take lumber prices, the symbol of inflation during the pandemic. It fell 14 of the last 16 trading days. It’s down 41% since its peak in May ($1,711 thousand board feet vs $1,009 yesterday). Copper prices are falling. The semiconductor shortage is getting fixed too. The only exception is oil. Oil continues to hold the line above $70/barrel. But oil was always it’s own different beast. Under Fed’s school of thought the inflation problem will solve itself once the supply shock is fixed. The market seems to have bought that narrative with the 10-year bond yield falling.

But that can’t just be it. It’s more than just supply chain bottlenecks. I think downplaying concerns about inflation is dangerous. Wages are increasing (see paragraph above), so this suggests that some of that “transitory” inflation is here to stay. The world central banks also flooded the market with cash with no indication of taking off the foot off the accelerator. 30%+ of the U.S. money supply was printed during the pandemic. The government is not reigning in spending any time soon. If history provides any indication, this will not end well, as an economic 101 textbook will tell you. What helps in this case is the U.S. is currently the world’s reserve currency. If it were to lose that status, to something like Bitcoin (I know outrageous thinking but cryptos are a thing), interest rates would increase and limit government borrowing.

Interest Rates

The Fed has a big meeting today and a policy announcement later in the afternoon. Nobody expects a change in rates (now at 0.0%-0.25%)  but the market will look for clues on when it will slow its aggressive asset purchase program ($120 billion/month). I think the market will really be looking at the set of economic projections mapping out forecasts for economic indicators like inflation and unemployment. The dot-plot chart shows expectations on when Fed officials expect interest rates to start rising. So far the economists consensus is around 2023-2024.

I find that hard to believe. Another 2-3 years of more gung-hoing? You telling me the economy can’t support a 0.25% raise in the next 2-3 years? With inflation gathering speed, a job market tightening, and the economy improving, I’m not sure what else policy makers need. Is this even responsible? Are they waiting for the market to overheat? If there’s overeating and rates start to spike, there will be enormous risks to an already fragile and over leveraged global economy. 

The key here is for Powell to communicate clearly and not make any surprises (2013 taper tantrum due to sudden policy change). Powell needs to give advance notice of when it plans to trim its asset purchases. Also the Fed need to be careful on trying to paint themselves in a corner with their inflation is only “transitory” position. They should soften their stand on that.

Biden-Putin Meeting

Joe Biden is the fifth President to meet Vladimir Putin (Clinton was the first).There’s already a history between both leaders. Biden was VP and former Chairman of the Senate Foreign Relations Committee. He knows what’s up. If this meeting helps defuse the tension between both countries, then good.

Republicans have attacked Biden for giving Putin an undeserved audience. I don’t know about that. Russia is a major power with influence. Biden knows exactly who’s meeting.They both called each other “killer”. So it’s not like Biden is bringing roses to a tea and cookie meeting (plus the tea might be poisoned). 

Politicians are hard to take seriously. It’s funny how the table changes when another party is in power. Where was the Republican criticism when Trump met Kim Jong-un without any conditions? Or Putin? I get it. They are playing political games. Democrats did the same thing (acting tough on Russia when Trump was in power).

Political games aside, there’s serious business on the table. It’s good that they meet face to face. I don’t expect much from the meeting. But if it can help defuse tension a bit, the better. The U.S. and Russia both have a lot to address (Ukraine, nuclear, cyberattacks, election meddling, Alexey Nalvany etc…). This is not a Hilary Clinton “reset” moment.

There’s no reset here. I think Biden will make it clear where the U.S. stands. If Russia wants to play cyberattack games, the U.S. can too. If the meeting ends with more stable relations and a roadmap to addressing major issues, then I would call that a good meeting.

The Cold War was what it was because of the almost non-existent communication between both powers. Both sides thought the other side wanted to blow them up.

The Big Four+

I wrote an update on the big four American banks by asset size (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo). I also looked at crypocurrencies, govcoin, regulations, fintech like Stripe and Square, and Power Corp.’s reorganization.

It’s published on Seeking Alpha and it’s probably available for free for a while. The first article is available here.


Summary

  • Banks had fantastic results. The question is what follows?
  • The pandemic hasn’t made the banks weaker; it’s made them stronger.
  • The health of the banking system is akin to taking a blood sample of the economy.
  • Banks have deposit problems. They have too much cash and are not making enough loans.
  • Regulatory relief expected as banks are flush with capital. Buybacks and dividend raises are expected to follow successful Fed stress tests.

This is the opening of a front-page article in the WSJ on U.S. banks: “Everyone is clamoring for a piece of U.S. banks.” This is quite the sentiment change from my last article on the big four U.S. banks back in October 2020; nobody wanted a piece of them. But in stock market age, that was a really long time ago. At the time bank results and stocks were getting hammered. The mood was grim. Yet seven months later the banks are still standing and look better than ever. The bank stocks on track for what could be their best year on record compared with the S&P 500. The S&P Bank ETF (KBE) is now trading at about twice their pandemic lows and has risen 30.3% year to date, outpacing the 12.6% gain in the S&P 500. Despite the strong push, the banks remain cheap when compared to the rest of the market. Banks trade at around 13x their expected 2022 earnings, while the S&P 500 trades at more than 22x.

Banks’ Q1-2021 results have come and gone. I wanted to take the time to digest the results. With the backdrop of an improving US economy and strong results, the shares of JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), and Wells Fargo (WFC) have rallied higher since my October 2020 article.

Today I wanted to provide an update and insights on the big four, the banking industry, Credit Suisse (NYSE:CS), regulations, fintech, and crypto.

I don’t track quarterly earnings like a hawk. But I particularly pay attention to bank results. They give you insights into the economy. They are alternative data. Just like Walmart and Home Depot gives you an idea of the health of consumer spending and the housing market. Bank results are like taking a blood sample of the economy. If the banks are not doing well, or worse they fail, it can have massive repercussions on the economy, like we have seen with the financial crisis of 2008-2009.

Thanks to heavy monetary fiscal stimulus, the doomsday scenario didn’t play out, at least at the moment of writing this. Bank results came in better than expected and are healthy.

Who would have thought that a year ago when we were wondering how bad the pandemic fallout will be? Who would have thought to bet on banks? The question is what follows? Investors are waiting to see how the banks will fare long term, as reserve releases are a temporary phenomenon.

But first, let’s resume how we got here?

The pandemic forced central banks in many nations to lower interest rates to rock bottom level.

Savers were not the only ones affected. In practice, interest rates on deposits cannot be lowered much beyond zero (negative rates may lead to withdrawal of deposits). Low interest rates reduce the interest spread (bank margins), the difference between the rate banks pay their creditors (deposits) and the rate they charge their customers (loans).

Because of the low interest rates environment, banks have been making their profit outside traditional credit and savings operations. They have focused on trading fees, asset management, and their capital market arms. When markets are chaotic, traders can still turn big profits. When the economy is flailing, investment bankers can help nervous companies raise cash or sell themselves. Deal-making activity has been strong, thanks to SPACs and a rich IPO market. Banks earn money on both sides of the SPAC equation—underwriting the IPOs and advising on the mergers. Capital markets activity has been a source of strength for banks throughout the crisis, helping them offset declines in revenue from core banking functions such as making loans.

You can read the full article on Seeking Alpha.