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What's Next for Netflix?

In its latest earnings report for Q2 2018 Netflix definitely disappointed. Revenues came in at $3.91 billion compared to an expected $3.94 billion. New subscribers came up short 1 million of those expected.

It also provided weaker guidance, expecting to ad only 5 million new subscribers versus an earlier expected 6 million, with most coming from international.

The stock market noticed, taking the shares from $420 down to $330, a loss of 21.42%. Is it time to bail on Reed Hasting's miracle firm? Or is it time to load the boat once again?

If you have any doubts just ask any former employee of Blockbuster. In 1997, Blockbuster was the 800-pound gorilla in the VHS video rental business, with 9,000 worldwide, a 31% market share, and a $5 million market capitalization.

Today, Blockbuster has only one store left somewhere in rural Alaska. There is but one company to blame for this turn of events, and that would be Netflix.

Not only did Blockbuster bite the dust, so did the entire $8 billion-a-year movie rental industry, including Movie Gallery, Hollywood Video, and the rental operations of Walmart (WMT) and Amazon (AMZN).

That year, Reed Hastings returned his rental of the video Apollo 11 a month late and was hit with a huge $40 late charge. He was struck with a bolt of lightning. "There must be a business opportunity here," he thought.

The next day, he and friend Marc Randolph bought an oversized greeting card, tossed the card, and mailed a CD in the remaining envelope to Hastings' house. It arrived the next day in perfect condition. It was a simple matter of geometry. While the CD sat in the middle of the envelope, the Post Office only stamped the corners. This simple experiment became the basis of a business that eventually grew to $186 billion.

Yes, and now you're all thinking, "Why didn't I think of that?"

Hastings was the scion of an East Coast patrician family, a member of the social register and a regular in the New York Times society pages. His great-grandfather, Alfred Lee Loomis, was an early quant who made a fortune.

He received his undergrad degree from Bowdoin College and then joined the Peace Corps. Following a two-year stint in Swaziland to teach math, Hastings then obtained a master's degree in Computer Science from Stanford University in 1988.

Hastings founded his first firm at the age of 30, Pure Software, which went public in 1995. It then merged with Atria Software in 1996 and as Pure Atria was acquired in 1997. That left him flush with cash and looking for new challenges.

Based on the successful mail experiment Hastings invested $2 million into the Netflix idea, which Marc Randolph ran for the first two years.

Netflix then become the lucky beneficiary of a number of sea changes in technology then underway, none of which it anticipated. Sales of DVD players were taking off. The Internet and online commerce were gaining respectability, and massive overinvestment in broadband led to exponential improvements in streaming speeds.

There was also a crucial Supreme Court decision regarding the Copyright Act of 1909 that protected the right to rent a video that you owned. Hollywood had been fighting rentals tooth and nail to protect their substantial profits from DVD sales.

Hastings assembled a team of former colleagues who managed to build a website and a primitive distribution system. The Netflix website went live on April 14, 1998. The site crashed within 90 minutes, overwhelmed by demand. A rushed trip to the nearest Fry's Electronics brought 10 more PCs, which were quickly wired in as servers. By the end of the first day, Netflix had rented 500 videos.

The DVD optical format first launched in March 1997, creating the DVD player industry. Sales reached 400,000 units by the first half of 1998 and prices collapsed, from $1,100 to $580 in the first year. Netflix was swept up in the tide and monthly revenues reached $100,000 within four months.

Since newly released titles were so expensive at $15, Netflix focused on older, niche films in anime, Chinese martial arts, Bollywood movies, and, yes, soft-core porn. Netflix later exited this market when Hastings accepted an appointment to the California State Board of Education.

The company thrived. The headcount rose from an initial three to more than 100. But it was losing money - some $11 million in 1998.

Then the company caught a major break. The French luxury goods tycoon, Bernard Arnault, CEO of LVMH, was desperate to get into the Dotcom Boom and invested $30 million in Netflix. This attracted another $100 million from other venture capitalists and angel investors.

This allowed the company to experiment with its business model. It launched next-day delivery in San Francisco, which proved wildly popular, new sign-ups, renewals, and customer loyalty soared. Then in a stroke of genius Netflix initiated its Marquee Program, which allowed customers to rent four DVDs a month for only $15.95 a month, with no late fees. DVD player sales in 1999 reached 6 million, but Netflix lost $29.8 million that year.

In 2000, the Marquee Program evolved into the Unlimited Movie Rental service and the price rose to $19.95. It included a free rental, which customers could obtain by entering their credit card data, which then renewed indefinitely. This is common now but was considered wildly aggressive in 2000. Netflix was also an early artificial intelligence user, using algorithms to find movies that both members of a couple would like based on past rental data.

Netflix is a company that did 100 things wrong, any one of which could have wiped out the firm. It was the few things it did right that led it to stardom.

Hastings worked out deals with manufacturers to include a free Netflix rental coupon with every DVD player sold. The move earned it valuable market share, but almost bled the company dry since most didn't return. But a labeling error caused hard-core Chinese porn discs to get sent out instead.

A programing glitch caused members' video queues to be sent out all at once, landing some happy subscribers with 300 videos all at once. Coupon counterfeiting was rife until the company began individually coding each one.

Netflix planned to go public in 2000. Existing shareholders rushed to top up their holdings in expectation of cashing in on a first-day pop in the share price. But the Dotcom Crash intervened, and all new tech IPOs were canceled for years. This episode of greed and attempt at insider trading left Netflix well-funded through the following recession. Netflix lost $57.4 million in 2000.

In the meantime, the installed base on DVD players reached 8.6 million by 2002. Then disaster struck. Hastings learned that Amazon was entering the DVD sales market, the only source of Netflix profits. Hastings flew up to Seattle to sell Netflix to Amazon. But Jeff Bezos only offered $12 million and Hastings walked. It was a rare miss for Bezos. DVD players dropped to $200, and demand for content soared.

An important part of the Netflix story was the self-destruction of industry leader Blockbuster. Hastings offered to sell Netflix to Blockbuster at the bargain price of $50 million. By then, Netflix had 300,000 paid subscribers compared to Blockbuster's 50 million. But Blockbuster charged late fees while Netflix didn't. That difference would change the world. However, CEO John Antioco passed believing that online commerce was nothing more than a passing fad. It was a disastrous decision.

To dress up the company's financials for an IPO in 2002, Hastings fired about 40% of the company's workforce to cut costs. On May 23, 2002, Reed Hastings stood on the floor of wealth manager Merrill Lynch as the stock started trading on NASDAQ under the ticker symbol of (NFLX) at $15 a share. The company raised another $82.5 million in the deal. A year later Netflix announced it had 1 million paid subscribers, and the stock soared to $75 and the stock later split 2 for 1.

Realizing his error, Blockbuster's Antioco launched an all-out effort to catch up with Netflix in online rentals. When that news hit the market, (NFLX) shares fell back to its IPO price of $15. Late in 2004, Blockbuster launched a clunky copy of the Netflix website, but without the magical algorithms in the backend that made it work so well. Blockbuster undercut Netflix on price by $2, offering memberships for $17.95. It immediately captured 50% of all new online sign-ups but continued with its notorious late fees.

Blockbuster Online was plagued with software glitches from the start and every day presented a new crisis. Netflix also fought back with its own price cut, to $17.99. Both companies bled money. Short sellers started accumulating big positions in Netflix stock. Hastings vowed to run Blockbuster out of the online market with a $90 a quarter ad spend.

This Netflix received some manna from heaven. Corporate raider Carl Icahn secretly accumulated a chunk of Blockbuster stock in the market and then demanded that the company pursue an asset stripping strategy. Icahn eventually obtained three board seats and became de facto CEO. So, to say that management time was distracted was a gross understatement.

Netflix received another gift when Walmart finally threw in the towel for online movie rentals. Hastings jumped in and did a deal whereby (WMT) would refer all future movie rental customers to Netflix.

Blockbuster finally decided to dump its despised late fees, costing it $400 million in annual revenues. Hundreds of stores were closed to cut costs. The downward spiral began. The value of Blockbuster fell to $684 million. With 4.2 million subscribers Netflix was now worth about $1.5 billion. Blockbuster lost an eye-popping $500 million in 2005.

DVD sales and rentals reached their all-time peak of $27 billion in 2006. Slightly more than 50% of Americans then had broadband access.

Blockbuster, growing weary of the competition from Netflix, finally decided to deliver a knockout blow. It launched its Total Access program in another attempt to bleed Netflix to death by undercutting Netflix's membership price by $2. It worked, and Netflix was facing another near-death experience. Blockbuster Online's share of new subscriptions soared to 70%, and total subscribers soared from 1.5 million to 3.5 million in months. The Netflix share fell to only 17%, and the company was now losing money for the first time in years.

In a last desperate act, Netflix offered to buy Blockbuster Online for $600 billion, and would have gone up to $1 billion just to eliminate the competition. An overconfident Blockbuster, smelling blood, refused. Movie Gallery and Hollywood Video were already on the bankruptcy trail, so why shouldn't Netflix go the same way?

And then the inexplicable happened. Icahn refused to pay Antioco a promised $7 million performance bonus based on the Blockbuster Online success. Instead, he offered only $2 million and Antioco resigned, collecting an $8 million severance bonus in the process. Icahn replaced him with Jim Keyes, the former CEO of 7-Eleven.

Keyes immediately pulled the plug on the Total Access discount, thus dooming Blockbuster Online. Instead, he ordered that the company's 6,000 remaining stores sell Slurpees and pizzas to return to profitability, in effect turning them into 7-Elevens that rented videos. It was one of the worst decisions in business history. Many of the senior staff resigned and sold their stock on hearing this news. Keyes in effect seized defeat from the jaws of victory.

Reinvigorated and with subscriptions soaring once again, Netflix launched headlong in online streaming. It introduced its set top box, Roku, in 2008. It then got Microsoft to offer Netflix streaming through its Xbox 360 game console that Christmas, instantly adding potentially10 million new subscribers.

And this is what makes Netflix Netflix. Although the company had the best recommendation engine in the industry, CineMatch, Hastings thought he could do better. So, in 2006, he offered a $1 million prize to anyone who could improve Cinematch's performance by 10%. To facilitate the competition, he made public the data on 100 million searches carried out by the firm's customers.

It was the largest data set put in the public domain. Some 40,000 teams in 186 countries entered the contest, including the best artificial intelligence and machine language and mathematical minds. It became the most famous scientific challenge of its day.

After a heated three-year struggle, a team named BellKor's Pragmatic Chaos won, a combination of three teams from Bell Labs, Hungary, and Canada. The copyright for the algorithm is owned by AT&T and licensed to Netflix for a fixed annual fee. AT&T also uses the winning algorithm for its own U-verse TV programming.

When the 2008 financial crisis hit, Netflix subscribers just kept on rising at the rate of 10,000 a day as consumers stayed at home and obtained cheaper forms of entertainment. Total subscriptions topped 10 million in 2009. Those at Blockbuster cratered. A new competitor appeared on the scene, Redbox, with 20,000 supermarket kiosks offering DVDs for 99 cents a day. But Netflix was hardly affected.

By 2012, Netflix subscriptions reached 20 million. Streaming was a blowout success, with half of its customers using streaming only to watch TV shows and movies. Hollywood beat a path to Hastings' door, with Paramount Pictures, Lionsgate, and MGM earning a collective $800 million in Netflix fees. Netflix now accounted for 60% of movies streamed and 20% of total broadband usage.

When Blockbuster finally declared Chapter 11 bankruptcy on September 23, 2010, so did its Canadian operations. That opened the way for Netflix to enter the international market, picking up 1 million new subscribers practically overnight. Next it launched into Latin America, introducing Spanish and Portuguese streaming in 43 countries.

As streaming replaced DVD rental by mail, Hastings attempted to spin off the rump of the business into a firm called Quickster. Customers would now have to open two accounts, one for streaming and one for mail and pay high prices. Customers and shareholders rebelled, taking the stock from $305 down to a heartbreaking $60. This was the last chance you could buy the stock at a decent price.

Hastings recanted on Quickster and let go the 200 staff applied to the unit. Icahn made a reappearance in this story, this time accumulating a 10% share in Netflix. After demanding management changes nothing happened, and Icahn eventually sold his shares for a large profit. Finally, Icahn made money in the video business.

Going forward, Netflix's strategy is finally straightforward. Create a virtuous circle whereby superior content attracts new subscribers, who then deliver the money for better content.

CineMatch knows more about what you want to watch than you do. The immense data it is generating gives Netflix not only the insight on how to sell you the next movie, it also proves unmatched insight into trends in the industry as a whole. It also makes Netflix unassailable in the movie industry.

That has given the firm the confidence to double its original content budget from $4 billion to $8 billion this year to produce Emmy-winning series such as House of Cards and Orange is the New Black.

So, the future for Netflix looks bright. As for me, I think I'll spend the rest of the evening watching the 1931 version of Frankenstein on Netflix.

July 30, 2018

Diary, Newsletter

Global Market Comments
July 30, 2018
Fiat Lux

Featured Trade:
(THE MARKET OUTLOOK FOR THE WEEK AHEAD,
or POURING GASOLINE ON THE FIRE),
(MSFT), (AMZN), (FB), (NFLX), (TWTR),
(TESTIMONIAL)

The Market Outlook for the Week Ahead, or Pouring Gasoline on the Fire

Diary, Newsletter, Research

Pour gasoline on a fire and you get a reaction. It's a simple matter of physics. That is the natural result of hitting the economy with tax cuts, fiscal stimulus, and low interest rates all at once. But at what price?

Of course, the headline number of the week was the first read on Q2 GDP growth, which came in at a strong 4.1%, the hottest number in four years. What was one of the biggest contributors? Soybean sales, as buyers rushed to beat the imposition of retaliatory Chinese tariffs. Consumers also hit the stores hard, spending their rising by a robust 4%.

The big question now is how much of this is sustainable? The answer is probably not much, which leaves investors with the queasy feeling that by coming in now they risk buying the absolute peak in the stock market. By temporarily pulling forward so much growth you may be creating a growth hole in Q3. So better mark your calendars now.

Q2 almost always delivers a string rebound from a usually weak Q1. The tax cuts delivered a one-time-only boost. But the investment spending that the administration had hoped for hasn't materialized, with a disproportionate portion of corporate profits going into share buybacks instead. Inventories are rising sharply, which is always bad.

We'll know for sure in a year when a recession will most likely begin. And remember, this extra growth is at the expense of an increase in the national debt by 10%, from $21 trillion to $23 trillion. And that is definitely NOT sustainable, but everyone in the world seems to have forgotten that, except me!

Interestingly, the report placed the current inflation rate dead on the Fed's target at 2.0%. That is a guarantee that any continued economic strength will be offset by rising interest rates.

The Facebook (FB) earnings highlighted the poor risk/reward of buying tech stocks at these elevated levels. Facebook shares plunged by 20% on their earnings announcement, creating the largest single day loss of market capitalization in history, some $120 billion. It was obviously a "kitchen sink" quarter.

If you get an earnings beat, as you did with Microsoft (MSFT) and Amazon (AMZN), you get a 2-, 3-, 4% pop in the stock price. If you disappoint, as did Facebook, Netflix (NFLX), and Twitter (TWTR), they crater by 10% to 20%. It is all typical end-of-cycle price action.

On the other hand, Amazon knocked the cover off the ball with its earnings, which came in at double analyst forecasts. The company is about to reach my end 2018 target of $2,000 a share. That is double the February lows.

Amazon Web Services delivered a stunning $6.1 billion quarterly revenue, up 49% YOY. Advertising is now becoming a major factor, as the company challenges Google (GOOG) and Facebook. For more on the longer-term prospects of Jeff Bezos's incredible company please see the special report that I published yesterday.

Bonds (TLT) continued their moribund price action, barely eking out a gain in yields to 2.97%. Either they are already discounting the next recession, are flooded with cash from a global QE hangover, or are getting a nice flight to safety bid brought on by multiple trade wars. Most likely it is all three.

Better to opine from the sidelines than to attempt to trade in the least volatile bond market conditions in 30 years.

As for gold, it continues to be a trader's worst nightmare as it plums new 2018 lows. Clearly, globally rising interest rates are not of what bull markets in gold are made. It doesn't help that Venezuela continues to hammer the market by liquidating its entire gold reserves on its way to national bankruptcy. Whenever distress liquidations take place, they are bad for everyone, not just the seller. Competition from crypto currencies for the speculative dollar doesn't help either.

As I have been sitting on top of an Alp contemplating the future and out of the markets, my 2018 year-to-date performance remains unchanged at an eye-popping 24.82% and my 8 1/2- year return sits at 301.29%. The Averaged Annualized Return stands at 35.10%. The more narrowly focused Mad Hedge Technology Fund Trade Alert performance is annualizing now at an impressive 38.69%.

It will be a big week on the data front, with an FOMC Meeting and an onslaught of jobs data.

On Monday, July 30 at 10:00 AM we obtain the June Pending Home Sales.

On Tuesday, July 31 at 9:00 AM EST, then we get the May S&P CoreLogic Case-Shiller National Home Price Index.

On Wednesday, August 1 at 2:00 PM, the Fed announces its decision on interest rates. Given the hot 4.1% Q2 GDP report, another 25-basis point rate rise is entirely possible.

Thursday, August 2, leads with the Weekly Jobless Claims at 8:30 AM EST, which saw a rise of 9,000 last week to 219,000.

On Friday, August 3 at 9:15 AM EST we get the July Nonfarm Payroll Report. Then the Baker Hughes Rig Count is announced at 1:00 PM EST.

As for me, the highlight of the week was being handed the keys to the City of Zermatt by the mayor for visiting for the 50^th year. Yes, I camped out here at the Youth Hostel in 1968. Also, with the honor came a Swiss Army knife with my name on it and a beautiful 10-pound coffee table book outlining the route I usually take to the Matterhorn summit.

I am now contemplating my return to the U.S., which is always hellish. It will require two trains (to Visp and Geneva), two flights (to Amsterdam and San Francisco), the last one of which lasts a punishing 10 1/2 hours. Then there is the eight hours of jet lag to deal with when I get home. So, I'll be getting up at 2:00 AM for a while. During those days I will be posting some of my favorite pieces from the past.

Still, to see the 14,692-foot Matterhorn from where I am sitting in the brilliant sunshine in all its glory, listening to an Alpine river rushing outside my window, and watching the swaying pines, it is all worth it.

Good luck and good trading.

July 23, 2018

Tech Letter

Mad Hedge Technology Letter
July 23, 2018
Fiat Lux

Featured Trade:
(THE SKY IS THE LIMIT),
(NFLX), (FB), (AAPL), (MSFT), (GOOGL)

The Sky Is the Limit

Tech Letter

After Netflix (NFLX) laid an egg, the tech sector badly needed a cure to calm the fierce, open waters.

Netflix missed expectations by about a million subscribers and weak guidance shredded the stock almost 15% in aftermarket trading.

The FANG boat started to rock and large cap tech needed a savior to quell the increasingly downside risk to the best performing sector in the market this year.

You can rock the boat all you want, but when Microsoft (MSFT) shows up, the seas turn tranquil and placid.

Microsoft delivered a dominant quarter.

I expected nothing less from one of the best CEOs in America, Satya Nadella, and his magic touch is the main wisdom behind the loquaciousness when the Mad Hedge Technology Letter delves into the Microsoft business.

I rate Microsoft as a top three technology stock, and it should be a pillar of any sensible equity portfolio, unless you believe throwing away money in the bin is rational.

Born in Hyderabad, India, Nadella has worked wonders inheriting the reins from Steve Ballmer who was more concerned about buying an NBA team than running one of the biggest American companies.

Ballmer had Microsoft barreling unceremoniously toward irrelevancy.

It got so bad for Microsoft, the "L word" started to pop up.

Legacy tech is the lousiest label a tech company can be pinned with, because it takes years and gobs of cash to turn around investor sentiment, the business, and the share price.

Under Nadella's tutelage, Microsoft has burst through to another all-time high, which is becoming a regular occurrence in 2018 for Microsoft's shares that languished in purgatory for years.

If the macro picture holds up and if the administration can keep quiet for a few news cycles, investors can expect a minimum of 15% appreciation per year in this name.

And that is a conservative estimate.

Microsoft is already up over 20% in 2018.

Queue the applause.

Nadella has orchestrated a 300% jump in valuation during his four and half years at the helm.

Microsoft is now valued at more than $800 billion and climbing.

The only other tech members of the prestigious $800 billion club are Apple (AAPL), Amazon (AMZN), and Alphabet (GOOGL).

Apple leads the charge to claim the prize as the first trillion-dollar company, and it is within striking distance valued at $951 billion.

Nadella bet the farm on software subscriptions and migration to the cloud.

It was the perfect strategy at the ideal time.

Shares cracked the $108 mark at the market open even as the administration kept up its pugnacious rhetoric threatening to topple the overall market.

Tech has held up through these testy times confirming the fluid migration by the scared investor souls into big cap tech.

How can you blame them?

Amazon prime day saw record numbers visit its platform to the point it crashed from overloading the servers.

Coresight Research predicted users would fork over $3.4 billion on Prime Day in 2018, an increase of 40% YOY.

More than 100 million products were sold in the 36 hours.

The staggering Prime Day sales came on the heels of Alphabet being fined $5 billion for being too dominant in Europe.

The market shrugged it off as the fine does nothing to change Alphabet's dominance in Europe.

Android has harvested 80% of the smartphone market and was slapped on the wrist for bundling Google apps out of the cellophane packaging is a cheap trick by the European regulators.

Imagine frequenting a restaurant that cannot serve its own food.

Alphabet even allows users to download whatever bundle of apps through the Google Play app store. It should be enough.

Alphabet is another solid Mad Hedge Technology Letter pick, albeit it is the weaker tier of the vaunted FANG group and just celebrated all-time highs.

Amazon and Netflix (NFLX) still lead the charge at the top tier of the FANG group, and Facebook's risky business model has it grouped with Alphabet in the lower tier.

At the end of the day, a member of the FANG group is a member of the FANG group.

Microsoft should be part of the FANGs, but the acronyms start becoming too pedantic.

The breadth of the tech sector means many winners.

Microsoft is one of the biggest winners.

Microsoft's total revenue levitated 17% YOY to $30.1 billion.

The number every investor was patiently waiting for were insights into the cloud business.

Microsoft Azure was up 89% YOY and cemented together with strong guidance, ensured Microsoft's shares would continue on its merry way upward.

Gross margins for the commercial cloud offerings, grouped as Azure, Office 365, accelerated to 58% YOY from 52%.

Microsoft's intelligent cloud described by Nadella as "Microsoft's drive to build artificial intelligence into all its apps and services" rose 23% YOY to $9.6 billion.

Management said that it expects Cloud margins to ameliorate through the rest of 2018.

Even the hardware side of the operations caught an updraft with Microsoft Surface, a series of touchscreen Windows personal computers, pole vaulted by 25% YOY.

Simply put, Microsoft is a lean, mean cash-making machine. Last quarter's profit of $8.87 billion coincided with the first time the company eclipsed $100 billion in annual sales.

Microsoft Azure's 16 percent share of the global cloud infrastructure market, according to data by research firm Canalys in April, is rapidly approaching Amazon's Amazon Web Services (AWS) business.

A Morgan Stanley poll of 100 U.S. and European CIOs gleaned insight into the broad-based acceptance of Microsoft's products.

The poll saw 34% planned to upgrade to a higher and more expensive tier of Office 365 software in the next two years, and more than 70% plan to deploy Microsoft Azure and its collection of hybrid cloud solutions.

Microsoft still has its cash cow business injecting healthy profits into its business with Microsoft's productivity and business processes unit, including Office 365, rising 13.1% YOY to $9.67 billion.

The tech sector needs the mega cloud stocks to stand up and be accountable at a precarious time when the macro picture is doing its best to suppress the robust tech sector.

Amazon and Alphabet are in the limelight next week, and Amazon will divulge frighteningly strong cloud numbers along with the braggadocio numbers about its record-breaking Prime Day.

The more I look at Microsoft's last quarter performance, it becomes harder and harder to identify any chink's in Microsoft's armor.

This is not your father's Microsoft.

This is the flashy, innovative Microsoft on top of the most influential trend in the technology sector - the migration to the cloud.

Sticking to this stock could be the rich new uncle of which you've always dreamed. But in this case, it's Satya Nadella providing the free flow of funds.

The spike in the shares is well deserved and any remnant of a retracement should be bought with two hands.

Saying that I am bullish about Microsoft's prospects is an understatement.

________________________________________________________________________________________________

Quote of the Day

"Your margin is my opportunity," said founder and CEO of Amazon Jeff Bezos.

July 18, 2018

Tech Letter

Mad Hedge Technology Letter
July 18, 2018
Fiat Lux

Featured Trade:
(IS NETFLIX DEAD?),
(NFLX), (AMZN), (FB), (TWTR), (DIS), (GOOGL), (QQQ)

Is Netflix Dead?

Tech Letter

Too far out over their skis.

For the first time in five quarters, Netflix (NFLX) was unable to eclipse the alpine level like expectations prognosticated by its own senior management.

Netflix and Amazon (AMZN) have been given luminary status at the Mad Hedge Technology Letter because the straight-line price action offers such agonizing entry points for investors, along with the best business growth models in the American economy.

Chasing this stock has usually worked out for the better, but leading up to the latest quarterly earnings report, Netflix started to scrunch up.

The firing squad loaded up its bullets and after Friday's close, shots were rained down on Netflix's parade as it failed to beat the only metric significant to Netflix investors - new subscribers.

The numbers were not even close.

Netflix fizzled out on its domestic subscriber's growth metric by 560,000, when 1.23 million new subscribers were expected.

International numbers succumbed to the inevitable, but less in percentage terms, failing to surpass the expected 5.11 million, only successfully adding 4.47 million new subscribers.

The 5.2 million adds out of the expected 6.3 million expected is the best news that has happened to Netflix in a long time if you are underinvested in this name.

Ravenous investors looking to jump on Netflix's bandwagon are licking their chops.

After-hours trading saw the stock tank, falling down the rabbit hole by almost 15%.

The stock had only recently been trading around an all-time high of $419. Fluffing their lines has given investors a much-awaited entry point into one of the creme de la creme growth stories in the vaunted tech sector.

Let's get a little more granular, shall we?

Even for high-flying tech stocks, the velocity of the price surges has put off many investors calling the stock "overbought."

Netflix shares were up 108% in 2018 before profit taking commenced before the earnings call. It was unusual to see Netflix intraday slide of 4%.

Investors smelled a rat.

It was only a matter of time before normal investors were finally given a chance to swiftly pile into this precious gem of a stock.

That time is now.

UBS analyst Eric Sheridan recently declared Netflix's growth story as "all priced in."

I don't buy it.

Yes, the shares got ahead of itself, but the Netflix narrative is still intact.

Over the earnings call, Netflix CEO Reed Hastings gushed about the current state of the company remarking that "fundamentals have never been stronger."

The bad news is that it missed on overzealous estimates; the good news is it added 5.2 million new subscribers.

Don't forget that in Q1 2018, Netflix beat total estimates by a herculean 920,000 subscribers, which is around what it missed by in Q2 2018.

The most recent quarter was overwhelmed by World Cup 2018 fever, with audiences migrating toward probably the most dramatic and exciting World Cup in history and the first to be streamed.

The most popular sporting event in the world gave Netflix a short-term kick in the cojones, delaying many new subscription sign-ups until after France lifted the trophy for the second time in its illustrious history.

The Twitter (TWTR) and Facebook (FB) numbers back up this thesis, experiencing explosive engagement and ad buying over the monthlong tournament boding well for their next earnings results.

Don't worry investors.

These eyeballs are just temporary.

The tournament offering a short-term bump to social media stocks clearly is just a one-off event that happens one summer out of every four.

Any recent profit taking will see the same investors eyeing a lower cost basis after this share dump.

Netflix won't be down for long.

Let's briefly review some of Netflix's cornerstone advantages:

The massive user migration from linear television to over-the-top content (OTT) led by cord-cutting millennials, responsible for a growing slice of domestic purchasing power.

The inherent advantages of a global over-the-top content (OTT) streaming model, applying massive scale with the cheap marginal cost of current technology.

The first-mover advantage that has allowed Netflix to have its own cake and eat it.

And the competition's laggardly response to Netflix eating its own cake.

Netflix CFO David Wells' take on the missed targets was "lumpiness" in the business and brushed it off like a bug crawling up your leg.

Hastings also chimed in about the increased competition shaping up and Disney (DIS), HBO, and other players finally getting their act together.

He mentioned there is room for multiple players in this industry, but they better not show up to the gunfight with a knife.

Netflix has been weaning itself from Disney's, Fox's and other third-party content for years, along with spending 50% more on marketing in 2018.

Ted Sarandos, chief content officer of Netflix, let it be known that 85% of new spending will be on original content in 2018.

Out of $8 billion earmarked for content in 2018, a colossal $6.8 billion is set to be splashed on in-house productions.

Compare this with the competition of Amazon, which plans to spend $4.5 billion on original content in 2018 and Hulu's plan to spend $2.5 billion in 2018.

Down the road, Netflix will have greater ability to finance its expensive content spend as it has flipped to a profit-making entity.

Amazon uses its AWS (Amazon Web Services) arm to fund its various subsidiaries.

The high level of quality content is reflected in the 40 Emmy nominations garnered by Netflix, in effect crushing stalwart HBO.

Netflix is aggressively courting Hollywood's A-list and poaching them in droves.

Proven content creators such as Ryan Murphy, Shonda Rhimes, Shawn Levy and Jenji Kohan are now on Netflix's payroll, and are a vital reason for the uptick in quality programming.

This successful harvest will result in added brand recognition and elevated prestige for current and future eyeballs.

Netflix will push out around 1,000 original programs in 2018. More than 90% of Netflix's subscribers habitually watch its vast portfolio of original programming.

The only way Netflix can be stopped is if it stops itself.

The pipeline is plush, and it is not all priced into the stock yet.

Next year could be the year India and Japan massage the bottom lines to greater effect, as Netflix double downs on the international arena.

Netflix's first original Indian series "Sacred Games" has been a winner, and its first original movie "Lust Stories" is creating a stir among avid Indian movie followers.

CEO Hastings has gone on record stating the "next 100 million" Netflix subscribers will derive from the land of Taj Mahal and chicken tikka masala.

Netflix has a lot of work to do to catch up with entrenched leaders Hotstar and Alphabet's (GOOGL) YouTube India.

About 800 million Indians have never been online before. The screaming potential India offers cannot be found elsewhere, especially with films historically, deeply embedded inside India's ancient culture.

Next month will see the release of "Ghoul," based on critically acclaimed work by authors Salman Rushdie and Aravind Adiga.

Slated for imminent release is also Mumbai Indians, a documentary about a top team in the locally obsessed Indian Premier League cricket tournament.

GBH Insights' internal research has found that Netflix is watched 10 hours per week in American households.

That number will inevitably grow as the quality of content goes from strength to strength for this first-rate company.

And how did Netflix's shock miss affect the Nasdaq (QQQ) on the next trading day?

It showed the resiliency and intestinal fortitude that has been a hallmark of the tech sector bull market.

The latest earnings result snafu is a surefire chance to finally have a little taste of Netflix. It will be back over $400 in no time.

________________________________________________________________________________________________

Quote of the Day

"If we continue to develop our technology without wisdom or prudence, our servant may prove to be our executioner," - said retired U.S. Army General Omar Bradley.

July 17, 2018

Tech Letter

Mad Hedge Technology Letter
July 17, 2018
Fiat Lux

Featured Trade:
(THE PATH AHEAD),
(IBM), (AMZN), (FB), (MSFT), (NFLX), (QQQ), (AAPL), (DBX), (BLK)

The Path Ahead

Tech Letter

The Red Sea has parted, and the path has opened up.

Technology has been a beacon of light providing comfort to the equity market, when a trade war could have purged the living daylights out of bullish investor sentiment.

If an increasingly hostile, tit-for-tat trade skirmish threatening overseas revenue can't bring tech equities to its knees, what can?

It seems the more bellicose the administration becomes, the higher technology stocks balloon.

Does this all add up?

The Nasdaq (QQQ) continues its processional march skyward. If you were a portfolio manager at the beginning of the year without technology exposure, then polish off the resume before it picks up too much dust.

The Nasdaq has set all-time highs even after a brutal 700-point sell-off at the end of January.

Apple (AAPL), Microsoft (MSFT), Netflix (NFLX), and Amazon (AMZN) can take credit for 83% of the S&P 500's gains in 2018.

And that fearsome four does not even include Facebook (FB), which has left the shorts in the dust.

Each momentous sell-off has proved to be a golden buying opportunity, propelling tech stocks to higher highs and retracing to higher lows.

And now the path to tech profits is gaping wide, luring in the marginal investor after two highly bullish events for the tech world boding well for the rest of fiscal year 2018.

Xiaomi, one of China's precious unicorns, which sells upmarket smartphones, went public on the Hong Kong Hang Seng market last week.

The timing couldn't be poorer.

The rhetoric between the two global leaders reached fever pitch with the administration proposing $200 billion worth of tariffs levied on Chinese imports.

China reiterated its entrenched stance of not backing down, triggering a tense war of words between the two global powers.

The beginning of March saw the Shanghai stock market nosedive through any remnants of support levels.

The 50-day moving average, 100-day, and 200-day were smashed to bits and Shanghai kept trending lower.

The trade skirmish has had the reverse effect on Chinese equities compared to the Nasdaq's brilliance, and combined with the strong dollar, has seen emerging markets hammered like the Croatian soccer team in Moscow.

Xiaomi's IPO was priced in the range of HK$17 to $22, and when it opened up on the first day at HK$16.60, investors were holding their breath.

Take the recent IPO triumph of cloud company Dropbox (DBX), whose IPO was priced in the expected range of US$18 to $20. The first day of trading showed how much appetite there is for to- quality cloud companies, with Dropbox starting its trading day at US$29, 40% higher than the expected range.

Dropbox finished its first day at a lofty US$28.48, a nice 35% return in one trading day.

No doubt Xiaomi's shares were not expected to perform like Dropbox, but it held its own.

Astonishingly, this company did not even exist nine years ago and is now the fourth-largest smartphone manufacturer in the world, grossing $18 billion in revenue in 2017.

The unimaginable pace of development highlights the speed at which the Chinese economy and consumer zigs and zags.

Chinese retail sales were up a staggering 9% YOY for the month of June 2018. Its overall economy met its 6.7% target for the second quarter of 2018.

The price range settled for the IPO gave Xiaomi a valuation of $54 billion.

Instead of getting roiled, Xiaomi came through with flying colors posting a 26% gain after the first week of trading.

Poor price action could have given Beijing ammunition to cry foul, laying blame for the underperformance on the U.S. tariffs.

The healthy price action underscores there is still room for Chinese and American companies to flourish in 2018, albeit through a highly politicized environment.

Specifically, Apple comes through unscathed as a disastrous Xiaomi IPO could have resulted in negative local press stoking higher operational risks in greater China.

Apple is in the eye of the storm, but untouchable because it employs more than 4 million local Chinese employees throughout its expansive ecosystem and has been praised by Beijing as the model foreign company.

Apple earned $13 billion in revenue from China in Q2 2018, a 21% YOY increase.

Hounding Apple out of China will be the inflection point when tech investors know there is a serious problem going on and need to hit the eject button.

If this ever happens, The Mad Hedge Technology Letter will be the first to resort to risk off strategies.

BlackRock's (BLK) CEO Larry Fink let everyone know his piece saying, "the lack of breadth in the equity markets is troubling."

Investors cannot blame tech companies for executing their way to the top behind the tailwind of the biggest technological transformation in mankind.

And even in the tech industry, winners can turn into losers in a blink of an eye, such as legacy tech company IBM (IBM).

Someone better tell Fink that this is the beginning.

Amazon recorded 44% of total U.S. e-commerce sales in 2017, equaling 4% of total retail sales in the U.S.

This number is expected to breach 50% by the end of 2018.

The second piece of bullish tech news was lifting the ban on Chinese telecommunications company ZTE.

It is open for business again.

From a national security front, this is an unequivocal loss. However, it saved 75,000 Chinese jobs and gave a small victory to American regulators attempting to patrol the mischievous behemoth.

The U.S. Department of Commerce lifted the seven-year ban even after ZTE sold telecommunication products to North Korea and Iran.

ZTE was fined $1 billion, changed the senior management team, and put into place an American compliance team that will monitor its business for the next 10 years.

Diluting the penalty lowers the operational risk for American tech companies because it shows the administration is willing to reach compromises even if the compromise isn't perfect.

China is a lot less willing to ransack Micron and Intel's China revenues, if America allows China to save face and 75,000 local jobs.

This is a big deal for them and their employees.

America has a strong hand to play with against China because China still requires Uncle Sam's semiconductor components to build its future.

This hand is only effective if Chinese still thirst for American technology. As of today, America is higher on the technological food chain than China.

The move is also a model of what the U.S. Department of Commerce will do if Chinese companies run amok, which Chinese tech companies often do because of the lack of corporate governance and transparency.

These two recent China events empower the overall American tech sector, and the market will need a berserk shock to the tech ecosphere foundations to make it crumble.

As it stands, the tech sector is handling the trade war fine, and with expected blowout tech earnings right around the corner, short tech stocks at your own peril.

________________________________________________________________________________________________

Quote of the Day

"All of the biggest technological inventions created by man - the airplane, the automobile, the computer - says little about his intelligence, but speaks volumes about his laziness," - said author Mark Kennedy.

July 16, 2018

Tech Letter

Mad Hedge Technology Letter
July 16, 2018
Fiat Lux

Featured Trade:
(THE REGULATION EFFECT),
(GOOGL), (AMZN), (FB), (SNAP), (TWTR), (NFLX)