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Friday, February 16, 2018

Netflix and the credit bubble

Netflix has always been a shady operation, in my opinion. Their streaming business depended entirely upon someone else being forced to pay for most of the enormous bandwidth costs that their delivery system required. They got away with that one somehow, but I think it is unlikely that they'll be able to get away with alleged accounting practices that sound creative even by Hollywood's infamous standards.
This almost-TV network will pay at least twice what anyone else will for original content, whether you are selling a TV series, film – or even a stand-up comedy special.

The modern version of this scheme is enabled by a very unique form of accounting hocus-pocus, used by the almost-TV network.  This accounting magic allows the company to claim that it is generating a “profit”.  The reality is that this company burned through about $2 billion of cash last year, and will burn through another $3-4 billion in 2018.

This almost-TV network simply depreciates the value of all these films and shows over a far longer period of time than everyone else ever has.  The company claims that their definition is legit, because the content is in their own “library”.

This almost-TV network is the 1st to deliver its content in a unique way, using relatively new technology – they were the first company to do it this way on a large scale.  This means the Feds presently have no basis to challenge the almost TV-network on its suspect accounting, because the new “definition” has not been proven wrong.  Only the ultimate financial collapse of the company will do that.  In the meantime, the accountants and auditors go along for the ride and happily collect their fees, as they always do.

The almost-TV network tells its stockholders that it can taper down this spending spigot in the future, to generate actual cash.  This is an obvious lie, in 2 ways.

If the almost-TV network ever cut spending and new content, many subscribers would drop them like a hot potato.  Second, the company is making many big public commitments to spend money like drunken sailors, for several years into the future.  The huge deal they made this week – that is just to the head guy alone.  It doesn’t count a penny towards what it will cost to make his shows.
This sort of corporate shadiness is yet another sign that the end of the most recent credit bubble is in sight. A commenter on the site had some interesting insights on the Netflix situation by making two historical comparisons.
The AOL fraud was based on an accounting scam where they capitalized all marketing expenses. All those CD-ROMs that you got through the mail and in magazines was claimed by AOL as a "research and development" cost. So could be amortized over seven years instead of charging them against that years accounts. So AOL not only never made any profit but had actually lost huge amounts of money. Which Time Warner discovered the hard way after the merger. Many billions of losses. Its not like everyone in the business at the time did not know that AOL was based on fraud.

The Softkey/Learning Company fraud was based on acquiring larger and larger software companies and greatly inflating the "goodwill" of the acquired companies. So their balance sheet looked great and the companies they acquired were cash rich and had great cash flows. But the scam needed bigger and bigger companies to acquire, like all Ponzi schemes, and when they ran out of companies to gobble up they sold the whole festering sack of shit to the nearest clueless idiot with money. In this case Mattel. Who a few years later had to write off $3 billion in losses and almost went bankrupt.
A friend of mine was involved with a very large corporation that grew through credit-funded mergers; his company was acquired several steps before the final end game. The company had billions in revenue and was worth many multiples more when it finally imploded. It was an extremely educational experience to be able to witness the whole thing gradually play out from the outside.

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51 Comments:

Blogger Emmanuel Mateo-Morales February 16, 2018 7:09 PM  

So I take it then you were in favor of net neutrality which is why you were silent on it when all the memes about the latest FCC chairman came out?

Blogger tz February 16, 2018 7:17 PM  

Karl Denninger has thouroughly analyzed it.

Because of "net neutrality" you subsidize them.

Netflix is a nice idea, but what happens ot Amazon Prime (4k) Video and Apple, and Google...

Blogger Michael Maier February 16, 2018 7:17 PM  

I so do not understand accounting. And I'm an accountant now.

Blogger VD February 16, 2018 7:19 PM  

So I take it then you were in favor of net neutrality which is why you were silent on it when all the memes about the latest FCC chairman came out?

I suggest you never, ever, assume anything about what I think on the basis of my not having said anything at all. Trying to put words in my mouth or trying to assign a position to me without my participation is an extremely bad idea for any commenter here.

I don't have a position on "net neutrality". I have never spent any time thinking about the FCC at all. So, you are completely wrong.

Blogger David The Good February 16, 2018 7:41 PM  

I may have to open a margin account. These things tend to blow apart really fast when they go.

Blogger Duke Norfolk February 16, 2018 7:53 PM  

Just think about the huge accounting departments and law firms and scores of MBAs, at places like Time-Warner and Hasbro, who apparently totally miss these frauds. I can't decide if that's plausible or not.

Or are they just afraid to tell the boss that his brilliant deal is beyond stupid?

Or does it just not really matter because the only ones who lose their jobs, like the CEO or other c-suiters, go out with so many millions that there's really no losers other than the shareholders.

Or maybe mass delusion. I dunno.

Blogger ChangYeeFong February 16, 2018 8:00 PM  

David The Good wrote:I may have to open a margin account. These things tend to blow apart really fast when they go.

Good point. But the trick is to know when. Cause from my experience with these types of schemes it can go on for a long time. Beside the Amazon example, in Malaysia over a decade ago there was a pyramid scheme called DKSH Lampberger which my wife got involved in before I met her. Well long story short they took all the money they got from the people involved in the pyramid scheme and now they are listed in the Malaysian stock exchange.

Blogger riffer73 February 16, 2018 8:07 PM  

Every audit failure I've ever seen came in "On Time and On Budget" Nobody is rewarded for finding problems.

Blogger Bullitt315 February 16, 2018 8:18 PM  

They have negative 1.8 billion in operating cash flows and borrowed 3 billion. Blame accountants all you want for estimates but looking at the financials it's not all that hidden. I'm an accountant and the entire silicon valley financials scare me. Companies that burn through cash do not last. Predicting when they'll collapse isn't so easy.

Blogger Erika Juhasz Nagy February 16, 2018 8:22 PM  

the problem is the timing. they will explode but when. someone will make a fortune shorting them at the right time. i track nflx daily. same for tsla, another bomb waiting to explode. amazon will be the third.

Blogger Christopher B February 16, 2018 8:31 PM  

This lines up well with some thoughts I had regarding 'net neutrality'. It got to be pretty obvious towards the end of the FCC repeal that the proponents were relying on people confusing the tv/radio push model of broadcasting with how internet 'broadcasting' actually works - Netfix et al don't need any bandwidth at all until someone makes a request to view something. They are depending on the carriers under-pricing their residential services to make streaming attractive (and keep Facebook, Twitter, Instagram free). If they actually had to pony up for the share of bandwidth they actually consume or carriers started charge realistic rates for residential service streaming would rapidly become to expensive to be viable. Now wonder they all wanted the government to forbid carriers from charging content providers for premium service.

Blogger bob kek mando February 16, 2018 8:33 PM  

Ryan Murphy is a fag.

how much of the Netflix negotiations were conducted in a bathhouse?

Blogger MycroftJones February 16, 2018 8:34 PM  

Was the Name/Url method of commenting permanently removed?

Also in the news today: James Damore's complaint against Google with the National Labor Relations Board was dismissed by NLRB lawyer Jayme Sophir, the daughter of Rabbi Bernard Lipnick. Never saw that coming! Damore is now pursuing his case through the regular courts.

Blogger 罗臻 February 16, 2018 8:34 PM  

Look at Netflix's balance sheet. Look at the increase in debt. Then look at the change in their content assets. Then change in net equity. The valuation of the company is going up based on content value. Even putting any scam aside, the value of the company is tied to accelerating leverage (look back a few years at that debt) used to acquire content. If they end up with a few Ishtars, they're cooked.

Their strategy isn't totally stupid: without content they have no business. Content owners are creating their own streaming services, what is Netflix's future?

Blogger MycroftJones February 16, 2018 8:38 PM  

So it is now official; the National Labor Relations Board will defend your employers right to fire you for politically incorrect beliefs.

Blogger VD February 16, 2018 8:39 PM  

Was the Name/Url method of commenting permanently removed?

Yes.

Blogger g wood February 16, 2018 8:40 PM  

The market can stay irrational longer than you can stay solvent.

Blogger pyrrhus February 16, 2018 8:41 PM  

This is an old story. Greentree Financial and Leasco had similar highly unrealistic depreciation practices, and both collapsed when the Ponzi finance ran out..And this claim about how the IRS can't challenge these non-GAAP practices is nonsense. The IRS doesn't challenge them because these companies have powerful lobbies in Congress and probably the WH...

Blogger pyrrhus February 16, 2018 8:42 PM  

The same thing happened with railroads in the 19th century. Insiders pump the stock, then dump it on the public, at which point it collapses...Many great fortunes were made that way.

Blogger Looking Glass February 16, 2018 8:43 PM  

The Blind almost covers both Netflix & Hulu. Netflix has been also financing their debt with rather long-dated bonds. Just had a sale this year for 10y notes. Everyone is basically in the "one streaming service to rule them all" game right now.

Disney's streaming service starts in 2019 (when a lot of their deals with Netflix ends), which is going to eat up a huge chunk of the market. If Disney has a "Disney + ESPN" package, they're going to be hard to beat for most cable-cutting households.

Oh, and Twitch has apparently passed both CNN & MSNBC for monthly viewership in the States. Amazon is going to make more money off Twitch than Google ever will off YouTube.

Blogger Nate73 February 16, 2018 8:57 PM  

Wouldn't "creative accounting" methods be more present at the start of a bubble than at the end of it?

Blogger Rough Carrigan February 16, 2018 9:14 PM  

The great white whale of fake accounting and meriting anti-trust investigation is still Amazon. A price to earnings ratio of 235:1. That's not a typo. I didn't accidentally type in an extra number. Two hundred thirty five to one. Dave Kranzler over at Investment Research Dynamics has written a couple pieces about Amazon's exploding debt and how they screw with their accounting in ways that even their scrofulous corporate colleagues don't.

Blogger wreckage February 16, 2018 9:18 PM  

The accounting could be legit, if the assets work like they are supposed to; that's plausible. The problem is they are leveraged to the ballsack. Even if they are 100% legit, a small disturbance could destroy them.

My guess is they are too late in this play to try to have thick cash walls when Disney attacks, so they've just gone for really really high ones. Teeter totter. SO if they have a rational approach, and if it works, once Disney is defanged they will try to consolidate.... but I doubt they will.

Blogger AnvilTiger February 16, 2018 9:22 PM  

In the long run Netflix will go bankrupt - but will simply be acquired by another corporation for the ownership of all of the content and the CDN. And the content will have some value, as will the content delivery network (CDN). Think of TMC - Turner Classic Movies. The Netflix shareholders will be screwed, but the consumers of the content won't care. The purchasing company will probably even retain the Netflix name (because after all, the name will be part of the purchase).

The previous reference to 19th century railroads is accurate. Most of those companies went bankrupt, but the physical stock remained and continued to operate, just by a different railroad corporation.

Blogger Emmanuel Mateo-Morales February 16, 2018 9:35 PM  

@4

*Shrugs Shoulders*

Sometimes you gotta poke the bear to know what he's thinking.

Blogger Jack Amok February 16, 2018 9:36 PM  

I may have to open a margin account. These things tend to blow apart really fast when they go.

It would fit in with a NN Taleb barbell investment strategy. Put most of your money in things that won't go to zero, but put some in things that a boom or bust. Shorting high-flyers is boom or bust.

Yes, the market can stay irrational longer than you expected, but the barbell strategy deals with that - you're not putting everything into the risky stuff, you're just putting enough that you have upside if it hits.

Wouldn't "creative accounting" methods be more present at the start of a bubble than at the end of it?

They're present all the way through, but likely even more common at the end where the greediest con men realize they should have gotten out a couple of years ago and are desperately trying to spin the plates long enough to find a sucker.

Cash flow accounting would fix this. Sure, cost-based accounting in theory works, but in practice, you couldn't do this kind of stuff with cash flow accounting.

Blogger 罗臻 February 16, 2018 9:37 PM  

The accounting is often clean at the start. A lot of frauds start with covering a small loss or cheating to hit numbers. Next quarter there's a bigger loss or they find the cheating is undetected and decide to keep using the same trick.

Blogger Ken Prescott February 16, 2018 9:39 PM  

No. At the start of a bubble, you're usually seeing irrational exuberance over legitimate profits.

At the end of the bubble everyone is trying desperately to keep the massive amounts of red ink from becoming obvious even to idiots and English majors (BIRM).

Blogger Emmanuel Mateo-Morales February 16, 2018 9:42 PM  

"Oh, and Twitch has apparently passed both CNN & MSNBC for monthly viewership in the States. Amazon is going to make more money off Twitch than Google ever will off YouTube.'

Really? Huh. Could have sworn that was Google that bought out twitch, but, then again, since Youtube has its own streaming service on it, it would kind of be redundant to own another service unless you just bought it out to shut it down so your main streaming service didn't have competition.

Blogger Azure Amaranthine February 16, 2018 9:43 PM  

"Wouldn't "creative accounting" methods be more present at the start of a bubble than at the end of it?"

How do you figure? I'd expect it to be the other way around. More creative bailing as the boat sinks deeper in the water and the paranoia starts to sink in. It's like how any lie snowballs.

Less creative accounting over time would indicate that they found some way to actually make good... but rule of thumb is that they're just switching to a new trick you haven't figured out yet.

Blogger Silly but True February 16, 2018 9:43 PM  

If they're pricing a reasonable value for Disney, say $10.99-$15.99 per month, then I think a good price for the Disney + ESPN package would be paying me about $29.99 monthly.

Blogger Lovekraft February 16, 2018 9:56 PM  

@23 Jack Amok:

"you're not putting everything into the risky stuff, you're just putting enough that you have upside if it hits."

I wonder if this would be similar to gambling on two sporting events. One is the low payoff sure-thing and the second is the longshot.

The first bet covers (usually) the loss if the second doesn't come through. I wonder if anyone's run these numbers.

Anonymous Anonymous February 16, 2018 10:28 PM  

Years ago when I worked at "famous retail corp not to be named" my manager would engage in what was called "inventory padding". The gist is, if you have to mark out/throw away two of 'whatever', claim that you tossed ten of 'whatever' and write that off as a loss. After all is said and done the books look much better. Actual profit has not changed at all, but profit on paper is better. In the long run, this is how companies die.

Blogger Jack Amok February 16, 2018 11:56 PM  

I wonder if this would be similar to gambling on two sporting events. One is the low payoff sure-thing and the second is the longshot.

Similar yes. Taleb describes it as being hyperconservative with some of your investment and hyperaggressive with some of it. I'd highly recommend Incerto if you haven't read it already.

Blogger wreckage February 17, 2018 12:30 AM  

Incerto? I haven't finished AntiFragile yet... I think he laboured the point a bit too much, and got bored. He's one of these guys desperately trying to make it fashionable to see what is, to many of us, blindingly obvious. Then he gets criticized for pointing out the obvious, because it's not "original" enough.... then society repeats the obvious mistake.

The notion of "antifragility" though is quite a good one to file away, and not one I've seen addressed much elsewhere; not that I read financial journals though.

Blogger LP9 February 17, 2018 1:00 AM  

This comment has been removed by the author.

Blogger One Deplorable DT February 17, 2018 1:37 AM  

@2 - Karl Denninger has thouroughly analyzed it. Because of "net neutrality" you subsidize them.

The facts don't back up Karl's theory here. I have the choice of fiber or cable Internet to my home. Neither service is metered. In fact, neither one has a formal data cap. And a data cap would be imposed long before metering if there was indeed a web site or service which was a "burden" upon the ISP, and which was disruptive to the people not using it. (Note the example of cellular ISPs backing off their initial offer of unlimited data for iPads back when the device was new.)

I can start a large download in the middle of the peak streaming period and not skip a beat. My neighbors may all be watching Netflix at 5 mbps but I can still download software or data at 75 mbps. And while price points or tiers remain fairly stable, speeds improve year over year.

I'll also note that I never saw an increase in price or a drop in service when Netflix became popular among my neighbors. In fact, I think that might have been around the time of a major speed jump from both local providers.

If there was ever any merit to Karl's argument, in the earliest days and markets, it has long since been rendered moot by the pace of technology. T-Mobile now excludes major streaming services like Netflix from user data caps. And that's on a relatively constrained cellular network. If that's what's happening in the cellular space then I don't buy for one second that my home bill would be lower or my service better absent Netflix.

Note: this is not to defend Netflix as a company or investment, and certainly not to defend their accounting practices. I just always found Karl's theory here to be absurd.

Blogger Alexandros February 17, 2018 2:11 AM  

People have speculated that Amazon only makes money off of their AWS sector, but is that really the case? If AWS is the only thing keeping them afloat, the fallout from that self destruction will be tsar-bomba level given how pervasive they are world wide.

Blogger Bob Loblaw February 17, 2018 2:37 AM  

Which Time Warner discovered the hard way after the merger.

It was more of a buyout than a merger. Steve Case's use of way over-inflated AOL stock to buy a real company was both the smartest and the shadiest move in business history.

But let's not pretend Time Warner didn't (and doesn't) do the same sort of accounting.

Blogger Bob Loblaw February 17, 2018 2:38 AM  

Alexandros wrote:People have speculated that Amazon only makes money off of their AWS sector, but is that really the case? If AWS is the only thing keeping them afloat, the fallout from that self destruction will be tsar-bomba level given how pervasive they are world wide.

Amazon is pouring huge amounts of money into its infrastructure. It makes sense from a tax standpoint - you'd much rather increase the value of company stock than book a profit.

Blogger SciVo February 17, 2018 4:53 AM  

Apparently there is some drama that I missed, but The Learning Company published the best computer game ever made: Robot Odyssey.

Blogger Desillusionerad February 17, 2018 6:10 AM  

Netflix new show, altered carbon (decent enough worth a watch) is indicative of the problem - it's highbudget as fuck, and in ways that really doesn't add to the show.
Netflix need to do more paint by numbers instead if grand spectacles - four cheap shows are better than one expensive one.

Blogger Matt February 17, 2018 6:22 AM  

I dont even want to pay my 25$ minimum credit card bill.

Blogger Lovekraft February 17, 2018 7:35 AM  

@39:

I'm on ep 5 of AC and beginning to lose interest. Started out interesting but the plot started to get too convoluted. The nudity, although sometimes tasteful, has reached the point where you start to think: are they doing this to compensate for a poor story? Getting too much.

Blogger 罗臻 February 17, 2018 8:02 AM  

AWS provides most of Amazon's growth and all of its profit. Technically more than 100 percent because other divisions still lose money.

Blogger S1AL February 17, 2018 8:03 AM  

So you mean to tell me that fiat currency leads to fiat accounting?

Blogger Purge187 February 17, 2018 9:31 AM  

I used to work for Netflix and was one of their most senior employees. I got six figures back when I dumped the stock that I'd invested a small percentage of my paychecks in. Glad I got out while the getting out was good.

Blogger Blaster February 17, 2018 2:28 PM  

First, the "A1" movie that the author is referring is Bright. Bright is a decently entertaining urban fantasy movie that triggered the hell out of SJW critics who led the charge panning it. Read any negative review of Bright and you're all but guaranteed to encounter SJW posturing. I haven't seen a movie so viciously attacked since Gigli, and Bright is much better than Gigli.

Also, a defense for Netflix's argument for a longer depreciation on its content. The devil is often in the details and I'm not an accountant or lawyer. But they have a valid point. Their situation is truly different.

People stream a lot of old content on Netflix, far more than they ever rented movies. The "library" is what has always brought people to Netflix and lack of it is what has tended to keep people away.

For example, I am not someone who would pay $200 for the DVD collection of Star Trek: The Next Generation, or frankly any other TV show. But I appreciate it being a part of the the Netflix subscription. My girlfriend watched the entire back catalog of Grey's Anatomy over a year and a half or so.

The appeal of Netflix is being able to sit down with a free hour or two and have something good to watch at your fingertips. No digging through a pile of dusty DVD/bluray boxes, no needing to decide whether to spend $5 on a rental fee-- just easy entertainment. For that convenience, people pay $11/mo, indefinitely.

I would not "drop the service like a hot potato" even if it stopped producing original content entirely. At this point, I have years of unwatched content. Granted, I don't watch a great deal of TV. But I do spend a few hours per week watching with my wife. It's enough to make the $132/year subscription worth it.

Blogger Blaster February 17, 2018 3:25 PM  

@41

The second half of Altered Carbon does manage to resolve the convoluted story effectively. It mostly ties together in the end in a way that makes sense.

There are some major flaws. I was never sold on Tak's devotion to Quellcrist, which is rather a major element of the story. The main villain didn't totally work for me. I think you're supposed to feel ambivalent, but to me I couldn't shake the feeling that it was two different characters crammed into one. The evil side is just so irredeemably evil that the residual virtues just ring hollow.

Blogger peppermint88 February 17, 2018 4:18 PM  

huge accounting departments and law firms and scores of MBAs

These "people" were students in school once. They did what they were told and were given Bs. They do what they are told and are given decent pay. They have neither the time, the training, nor the inclination for strategic thought. This is the result of post-war communist subversion, communist infiltration, communist indoctrination, and the international communist conspiracy.

Blogger peppermint88 February 17, 2018 5:07 PM  

the content will have some value, as will the content delivery network (CDN)
Content is only considered even watchable in The Current Year, CDN is network equipment from the current year.


probably even retain the Netflix name

which is synonomous with gay interracial transaged "sex"

Most of those companies went bankrupt, but the physical stock remained and continued to operate, just by a different railroad corporation.

The big difference between silicon valley and prior asset bubbles is silicon valley produces negative value in the form of intrusive social justice ads.

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