Motley Fool Hidden Gems Investing - Netflix Rising, WWE Preparing

Episode Date: October 19, 2022

Netflix surprises Wall Street and throws down the gauntlet at streaming competitors. (0:21) Tim Beyers discusses: - 3rd-quarter profits, revenue, and subscriber growth coming in higher than expected - Optimism around Netflix's new ad platform - Why he believes the stock is fairly valued (with room to run) (11:00) Nick Sciple and Jim Gillies discuss the business of World Wrestling Entertainment and how the company may be preparing itself to be acquired. Companies discussed: NFLX, DIS, AAPL, WWE, CMCSA Host: Chris Hill Guest: Tim Beyers, Nick Sciple, Jim Gillies Producer: Ricky Mulvey Engineers: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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Motley Fool Senior Analyst Tim Byers. Thanks for being here. Thanks for having me, Chris. fully caffeinated, ready to go. Likewise, which is good because Netflix is on the docket. The third quarter profits and revenue were higher than expected. They added 2.4 million net subscribers, which was more than double what they had guided for. I'm not saying they were sandbagging. Let's just politely say that they under-promised and over-delivered and shares of Netflix are up 15% this morning. You could say they were sandbagging. You could say it. Let's go ahead and say it because that's a huge difference. They did say 1 million paid net ads coming into this quarter. They end up at 2.4 million instead. And materially, all of that, Chris, comes from Asia Pacific and EMEA. So in the Asia-Pacific region, 1.4 million paid memberships, that was versus 2.2 million in last year's Q3, and 0.6 million versus 1.8 million in the year-ago quarter.

But that's essentially it. I mean, only 0.1 million, so 100,000 paid net ads here in the U.S. and Canada, and that's a penetrated market. We expect that, but this is an international story, and it's an international story that's getting more and more rich. One more point on this, Chris, before we move to the next question. This is why the foreign exchange was such a drag on results. So total revenue up 6% year over year in the quarter. That would have been 13% if you take out the effect of foreign exchange. you know, our buying power overseas because of the strong dollar is good. I guess that's great if you're on vacation in Bora Bora, you know, Chris, but neither of us is on vacation in Bora Bora.

Something tells me we're going to be hearing this repeatedly throughout earnings season. Something we're not going to be hearing repeatedly from Netflix, however, is guidance on subscribers because they came out this quarter and said, we're not going to be providing guidance on subs anymore and made it very clear, we want shareholders and we want Wall Street to focus on our revenue and our profit. I get why they're doing that. I mean, for a long time, it made sense for them to stress their subscriber growth. But at this point, look, all's fair in love and business, and this is fair it's completely fair i love it i i don't get anybody who sees this as a red flag i love it because the business has changed and the advertising component is going to be massive here

and because it's going to be massive it makes more sense to report on revenue like report on the subscriber additions. Absolutely. And they're going to continue doing that. They're just going to keep sharing the same metrics they have always shared. They're just not going to guide to the members anymore. And here's the reason you don't do that, Chris, because once you start introducing the advertising tier, if you were going to keep guiding to memberships, you're going to have to guide to not only paid subscription net ads, but also advertising ad tier net ads. And how do you differentiate that? How do you forecast that? I think the answer is you don't know because you really can't tell if somebody comes in and they're an ad tier subscriber, do you care if they're an

ad tier subscriber? And you could say yes if there is a material difference between an ad tier subscriber and a subscription tier subscriber. And there were some interesting comments during the call yesterday that I think reassures me, Chris, that the ad tier subscriber is going to be very much like the subscription tier subscriber. And we can go deeper on this, but here's the headline of what they said. We expect that the ad tier is going to be revenue neutral or slightly accretive, both on a revenue basis and longer term on an incremental profit basis. In other words, the $6.99 ad tier is going to be essentially the same in terms of revenue and profit contribution as the basic subscription tier at $9.99.

So, you're going to get roughly $3 of revenue from ads, at least initially. That's what Netflix is saying. I find that pretty reassuring, Chris. I think so. you know, they said they're very optimistic about the ad business, and you're right, it makes sense that, you know, this is one more reason to not guide for subs anymore, because it's like, there's a whole piece of this that Netflix doesn't know how it's going to go. They can be optimistic, they are, and they should be, but they don't know how it's going to go, and they won't

know until they've got a few months under their belt of what this is like. So, it all starts on November 3rd. I also think this is just going to be fascinating to watch for Disney as well, when Disney gets ready to roll out its ad-supported tier. And this is one of those things where if you are, depending on your level of interest as an investor, you can start to look at things like the Wall Street Journal's daily column on marketing. And we're going to start to hear things from advertisers, from media buyers about what their experience is like on these, for them, brand new ad platforms, what kind of insights they get, what kind of data analytics they get. And it's not all going to be amazing. No, it's not all going to be amazing. And here's

what's interesting. Netflix is even preemptive of this. In fact, I think you could almost say, should we celebrate or be scared of salty netflix because netflix is getting salty they did say literally in the the top of the shareholder letter this was bullet number five our competitors are investing heavily to drive subscribers and engagement and they believe operating losses from those competitors are and i'm i'm using quotes here so you can't see me so i'm using air quotes here well over 10 billion in other words saying without saying it our competitors are well behind us they are gonna have to you think we have a premium price get ready they are gonna have to raise prices they are gonna make some sacrifices because we're a profitable business

they aren't and they're gonna have to come to us we don't have to go to them salty netflix i kind like it, Chris. Yeah, I'm not a shareholder and I absolutely love Salty Netflix. I would always rather, all things being equal, I would always rather that companies take that tack rather than play the victim card. Absolutely. I'm a fan of Salty Netflix. Where do you think this stock is right now in terms of its attractiveness? Because it's up 15% today. Year-to-date, it is still down more than 50%. By a lot, yeah. It's very interesting. There are multiple ways to look at this. I don't want to call it anything more than fairly valued right now, Chris, because there are some assumptions baked in here. This is a company that does generate cash flow, but it does have significant capital

investments still to make. Please don't forget that they do make $17 billion of content investments every year, and they are committing to that over the very long term. So that does not go away. But they are a free cash flow generator, and I think they're in the range, at least right now of generating a billion dollars in free cash flow in any given year. And they do see that rising over time as they get the benefits of the ad tier. And there are, if I was going to make a bet on Netflix, the thesis I would bat around here, Chris, is that Netflix has a big lead

and potentially an enormous competitive advantage around global distribution. Disney is still a company that has global distribution, but global partners, and they have not decided to break the hearts of those global partners and say, look, we are going to take over the business of owning those customer relationships in Korea, China, Japan, you know, Brazil and so forth. They haven't taken over that yet. They've relied on those local distribution partners, in which case those local distribution partners do kind of dictate the advertising market in those areas. Netflix doesn't have that problem. Netflix has a global advertising platform and a global audience. And so when they go out with an ad tier in November in 12 markets, they're going

to be able to test advertising that is accretive to them in those markets i think the global nature of netflix's business is still it's shocking to me that it's still underappreciated but chris i still think it's underappreciated and as long as that remains true there is the possibility that this stock has a lot more room to run and buyers always great talking to you thanks for to be in here. Thanks, Chris. There are thousands of publicly traded companies, but only one of them has a top 10 channel on YouTube, and that's World Wrestling Entertainment. WWE has more than 90 million subscribers on YouTube, and the company may be getting ready to be acquired. To give the

smackdown on this content business. With Motley Fool Canada's Jim Gillies, here's Nick Sciple. With the S&P 500 down over 20% this year officially in bear market territory, it's not often you'll find a stock trading at its three-year high. In the entire history of the stock market, I don't think you'll find many businesses doing that three months after their chairman, CEO, and controlling shareholder resigns due to a sex scandal. Nevertheless, That's the story we find ourselves in with World Wrestling Entertainment today, more commonly known as the WWE. Before we get into Vince McMahon's resignation though, let's set the stage on the WWE investment thesis. WWE has been a recommendation in Hidden Gems

Canada since May 2021 and in Stock Advisor Canada since March of this year, well before this Vince McMahon investigation and resignation took place. Jim, can you give our listeners a quick overview of the investment thesis before this latest controversy? Sure, yeah. We weren't banking on Vince McMahon exiting due to sex scandal, although those of us who follow the industry weren't entirely surprised. The basic thesis is that this is no longer a live events company, and people didn't really notice. Vince McMahon, the background, Vince McMahon came out of what was called the territory systems of the wrestling industry through the 80s and 90s. Those of you who remember terms like Hulkamania

or the Attitude Era, those were different times when wrestling got hot. But throughout all of this, as the overarching point for all this, Vince McMahon rolled up an industry that no one else realized that they wanted. It was always very territorial. You had a territory in the upstate New York, you had the Carolinas, you had Florida, you had Portland, Texas, Calgary, of all places. But those operated kind of fiefdoms, and wrestlers, independent contractors would move around. Vince McMahon kind of rolled up, went national, has now gone international. And in the words of a colleague, a friend of ours, he kind of took over a mountain that no one else knew they wanted. So, they now have basically

control of this industry for all intents and purposes. There are other competitors, but basically, they're the big dog. And essentially, what they have done as well is, this is no longer a live event, so people go, oh, you know, I'm not going to go to a wrestling show, it's too expensive. No, this is actually a content provider. And in a streaming world where content is king and expensive and going up, and Nick, you know the numbers better than I do, so I'll let you list them off, but just think about some of the deals that you've heard, Fools, for Thursday night football, for baseball, for various hockey or MLB or UFC rights. WWE is benefiting from that very high inflation environment, and it looks like they're going to

continue. This is a content creator that happens to run live shows. It's not a live touring exhibit anymore. Yeah, absolutely. Similar to other sports leagues, you think about the NFL. People go to NFL games, but the main driver of NFL revenue is media rights, and that is no different for the WWE. And the reason those media rights are paid such a high premium for is because these are events that audiences show up for, and the WWE audience is very, very large. If you look at audience measurement data by YouGov, WWE has more fans in the 18-34 demographic than the NFL, MLB, NBA, UFC, NHL, and NASCAR when you measure it across all platforms. That's not just TV, YouTube. They're the largest sports YouTube in the world with over 90 million followers,

largest sports TikTok in the world. And that's transitioned to really significant payups for WWE rights in the past. The last time Raw and SmackDown rights were renegotiated with NBC and with Fox, you saw a 3.5X increase in rights fees. Those deals are going to come due in 2024, likely to see a big increase there as well. Also, what WWE has done over the past several years is, in the mid-2010s, WWE launched WWE Network, where you could watch the traditional pay-per-view events, WrestleMania, SummerSlam, those sorts of things. In 2021, they licensed that platform to Peacock in the U.S. for a rumored billion-dollar deal over five years, and they've been running that same playbook across the world. So, Peacock in the U.S.,

partnered with Hotstar in Indonesia, Foxtel in Australia, really licensing this content out across the world to streamers that are looking to gain scale and capture audiences, which, as we mentioned, WWE has. We expect these rights deals to continue going up in the future as more and more folks enter the streaming competition. We've seen Amazon get involved in sports rights deals. Apple has been getting involved potentially in NFL Sunday Ticket. This rising tide is going to lift lots of boats in the sports media landscape, including WWE. That's the thesis. With that thesis in mind, let's talk about Vince McMahon, the scandal, what's going on with the company. This summer, WWE Board of Directors initiated an investigation. That investigation uncovered

$19.6 million in payments that, quote, were not appropriately recorded as expenses between the years 2006 and 2022. In particular, the most troubling of these is about $15 million of these payments were allegedly paid to women for their silence about affairs and other misconduct. As a result of that, on July 22nd, Vince McMahon retired as chairman and CEO of the WWE, although he remains its controlling shareholder. You hear that, this guy who's been responsible for building the business for over 30 years, a guy who has been the creative captain of the ship, you would expect the stock to maybe be down a little bit. It's up 14% since that announcement. Why do you think that is, Jim? Well, twofold. First, whenever we

talk about Vince McMahon, I do like to share a little piece of investing trivia. WWE came public in 1999, one day away from another company called Martha Stewart Living Omnimedia. If you were to have picked on that week, if you were to pick which CEO would have served jail time, I'm willing to bet that not one person would have picked Martha Stewart, everyone would have picked Vince McMahon, because he is a bit of a controversial figure. But I think the reason why the stock has held up as well as it has is twofold. One, they actually have a pretty good bench strength. In fact, I can make the argument that the product that you see on television, and by extension, those premium live events, had gotten a little bit stale. Vince McMahon

was or is in his late 70s. He may not be plugged into what audiences want today, but fortunately, they have some pretty good bench strength, not the least of which includes his daughter Stephanie McMahon, who is the former, or I guess current still, but that's not her main role, Chief Brand Officer. Her husband, Paul Levesque, aka Triple H, who returned to the company. He had been off for some heart-related ailments. He came back and took over as Head of Talent Relations, Chief Content Officer, I believe his title now is, the day that Vince retired. And Stephanie, actually, I think they knew something was coming because Stephanie even took, she had taken a bit of a sabbatical to spend more time with her family and her

ailing husband, and it just happened to coincide with the scandal breaking. So, I think they were setting up to have them come back in if things went the way that it turned out they have. So, I actually think there's a lot of bench strength here with people who understand the industry and are actually more connected with what today's audiences want. So, that's No. 1. The second thing is, I think this company is going to get bought. And so, I think that there's a number of signs, and we can discuss those, but there are a number of signs saying, okay, yes, $20 million roughly in improperly recorded expenses. That is not great, but it's frankly not a lot for a company that did $1.23 billion in revenue over the past four quarters

that has done almost $380 million in what they call OIBDA, that's operating income before depreciated amortization, their weird version of EBITDA. It sounds bad. It is bad on an individual level. But from a business perspective, I think clearing Vince McMahon, somewhat out of touch, and perhaps an impediment to a sale, because right up to his retirement, was very, very, very hands-on by all accounts. I think this frees up the potential for a sale, as well as some of the things we can talk about as well. Right. You talk about that bench of wrestling talent. Stephanie McMahon, Triple H have both been in this business 25 plus years. If you look at the ratings on particularly Monday

Night Raw, set two-year highs in August in the aftermath of McMahon leaving and Triple H taking on the creative duties at the company. Another thing also worth mentioning, we mentioned Stephanie McMahon and Triple H as being the wrestling side of the company running the day-to-day operations. You also have a really strong executive in Nick Khan, who has now into the co-CEO role as kind of WWE's chief negotiator. Before he joined WWE, he was actually WWE's media agent helping negotiate their sports rights deals, and he's still there doing that today, helping to sign some of those deals I talked about, whether it's with Peacock or some of these international partners. So, you have a strong bench of wrestling talent to keep

the content running, and then the business folks making these deals to sell the content, still a very strong team there. Jim, you mentioned some signs that you think that that WWE might be getting ready to get acquired. What are you looking at? Well, first of all, there's just the general partnerships that they have. You talked about SmackDown and Raw, which are their two live Monday and Friday night live programming. They also have a Tuesday night programming at NXT, which is more of their minor leagues, the junior hockey or college basketball of wrestling, if you will, where people go to learn and hone their craft. SmackDown airs on Fox, so put that over

over here for now. Practically everything else, you mentioned the Peacock Network, Raw is on USA Network, NXT is on USA Network as well. There's one company that owns all of those things, it's NBC Comcast. They've had a very long-term relationship with WWE. Again, as you mentioned, content is king, streamers are looking for content, and content that can't be replicated or not easily replicated. Especially if it's live, it's not easily replicated. I think there's a lot of sense there that NBC is a natural acquirer, but it wouldn't shock me if someone like a Disney or even a wildcard in Amazon were to make a bid and work this out. But there's a couple of things. I know you've got one signal, so I'm not going

steal your signal, but I'm going to give you one that's something that I watch for, and I didn't notice this until today as we were prepping for this show, actually, but it's a signal. There's a filing that you'll find on the SEC websites for companies. It's an 8-K. It's basically a press release. It's called an 8-K, but it's like, every time a company releases earnings, they'll file an 8-K. Anytime a company releases material news, they'll file an 8-K. There are little subheadings that you can see that will talk about various things. If it's an earnings release, it'll be subheading 2.02, 9.02. There is something when it comes with call to executive movements, so a new director or an executive leaves, that subheading is a 5.02. I'm always interested to

see an 8K file just with a 5.02. I always make a point of reading those. I go in, I hit Control-F, and I look for change of control. Because it's a tell. It's not a perfect tell, but it's a tell that's been accurate more often than not in my experience. You see a 5.02 and you go in and look at change of control provisions. Companies preparing or at least contemplating selling themselves want to go in and make sure their executives are well taken care of in the event of a change of control. This happened when Oakley got bought by Luxottica. I think it was three months later they got bought. This happened when Nokia bought Navtech. That was very quick, if I remember, if memory serves there. This happened when Monsanto got bought by Bayer.

It was about a year, year and a half before they got bought by Bayer, or it got announced that Bayer was buying them. They went and changed this little 5.02. Well, it just so happens in September of this year, following the ascension of Stephanie McMahon, following the ascension of Paul Levesque, aka Triple H, and Nick Kahn, everybody got extraordinarily well taken care of in a change of control. Everyone got their salaries bumped because they've gone from a lower level executive, now they're co-CEOs in the case of Kahn and Stephanie McMahon. Everyone's got real nice sweetheart packages for two years following a change of control. This is textbook for companies contemplating acquisition. They want to make sure the people, the incumbents who are steering the

ship do very, very well. That's the signal that I found going, didn't notice that before, very intrigued now. Nick, you got another one? Yeah, certainly. Also in September, you saw some changes in the board of directors and some of those board members that are brought in have extensive M&A experience. Why would you want to bring in M&A expertise? Well, maybe you're probably looking to either sell yourself or go buy another company. Certainly, next year, we would expect if they follow similar patterns to what they did in the last rights renegotiation for Raw and SmackDown, we'd expect those new rights deals to start coming down next summer. To the extent a company might want to acquire the business instead of signing a new five-year

rights deal, it might be a time for that to take place. But even if, I want to emphasize, you don't need an acquisition to take place for this company to work. If you see another 3.5X increase in Raw and SmackDown rights deals, like you saw in the last cycle, then the stock is going to do very well. That's generally the thesis with the company today. Maybe to close off here, Jim, we said that this controlling shareholder of the company has left the business, resigned. To what extent has that changed your thesis around WWE today? The only thing it's done is that it has increased my belief that this company is going to be acquired, probably sooner rather than later. I think it

would not shock me that Vince might want to get some of his money out. Him and the family have about 87% voting control, he has over 80% personally. If he decides he wants to sell, there's not a lot anyone's going to be able to do to dissuade him. But I think Vince McMahon, Over its history, I've followed this industry for a long time. Vince McMahon likes money. I think there's no disputing that. I think Vince McMahon will absolutely cut himself the best possible deal for him and his family and his legacy. We know he's had little sidebars he's tried to do in the past. WWE has got a movie studio with middling success. He's tried to run a football league. He started the World Bodybuilding Federation back in the 1990s,

I think. He always, I think, needs to get his fingers into something. I think he's very driven. And boy, if he had a couple billion dollars upon sale of WWE, he could have a little bit of fun in his twilight years, shall we say. With him out, I think making sure his family is taken care of, which they've now done with the change of control at least. I think Vince will be very amenable to hearing offers. They are constructing a new headquarters building right now. Once that's done, I think that will probably be the hangout, the for-sale signal. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based

solely on what you hear. I'm Chris Hill, thanks for listening. We'll see you tomorrow.