What Investors Might Have Missed About Netflix

 In this podcast, Motley Fool senior analyst Tim Beyers discusses:

• Netflix's first-quarter results.
• Why he believes the new ad-tier model is off to a strong start.
• What Ted Sarandos said on the call that many investors may have missed.
• The shuttering of DVD.com.

Motley Fool producer Ricky Mulvey and Motley Fool senior analyst Asit Sharma take a closer look at Monster Beverage, its eye-popping returns so far this century, and where it could go from here.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on April 19, 2023.

Chris Hill: Netflix announces the end of an era, Motley Fool Money starts now. I'm Chris Hill; joining us today, our man in Colorado, Motley Fool senior analyst, Tim Beyers. Thanks for being here.

Tim Beyers: Thanks for having me, fully caffeinated ready to go here. Lots of movies.

Chris Hill: Lots of movies, Netflix, first-quarter results, they seemed fully caffeinated as well. Shares are down 3% and there's a few things I want to get to with Netflix. I'm curious if you are at all surprised by the reaction of what's happening with the stock today. Because this really did seem a good quarter. It seems like the drop in the stock is tied at least partially to Netflix saying, hey, the crackdown on password sharing. That's coming three months later than we originally said.

Tim Beyers: Yeah and yet I'm not too surprised by that, Chris. So in the US, it's coming in Q2. So essentially, now, and I will say that they tested it in four territories. The tests look very good and I think there were a lot of good signs in this quarter. Let's get to the password sharing in a second, but just hitting some of the top-line numbers. Chris, total revenue 8.16 billion up 3.7% year over year. I know that doesn't sound like a lot, but there are some foreign currency exchange headwinds there. But I think we've been saying this, Chris, that this is a more efficient business and it is increasingly a very efficient business,1.7 billion in operating income, that's 21% operating margin. That is delicious, that is excellent, 232.5 million global streaming paid memberships. That's up slightly from Q4. It's not perfectly linear. There were more in Q3 of 2022, but 4.9% year-over-year growth here of global paid streaming net additions, 1.75 million. Chris, they are adding members. They are generating profits at a pretty high rate and they raised their guidance on free cash flow from a full-year estimate of 3.08 billion at a minimum to now a minimum of 3.5 billion. Can we just park on that for a second? This is free cash flow. We're talking about. Netflix is saying, yeah, we think we're actually going to have an additional 420 million minimum on top of what we already told you. This is a company that's getting more efficient, generating more cash while its competitors are having to, I mean, not to get too dramatic here, Chris, but lighting some stacks of cash on fire in order to get scale and Netflix is not doing that. It has the scale and is reaping the rewards.

Chris Hill: They have cut their content, spend, like a lot of their competitors have there been slashed it, they've been taken a machete to it, but they've not an owned they've ranged it in some and the early results on the ad tier model appear to be promising. But I guess there's a question mark there. That's not a statement for me. Let's turn it into a question. How promising is the ad tier model right now? Because on the surface it looks like they're off to a pretty good start.

Tim Beyers: I think they're off to a great start now, in typical Netflix fashion, during the earnings call, they got asked about what they would expect at the upfronts and so for those who don't know, the up-fronts are where entertainment companies with advertising slots to sell in their programming go to advertisers and say, here's our inventory, what would you like to buy? There are commitments made for those certain programs and so given the results we're seeing, the question was about, hey, this is looking pretty good. How excited are you or how much do you think you're going to be able to get out of the upfront and they were very cagey. They were unwilling to answer Chris, but they did say that the average revenue per member for the ad tier now is on par or better than the standard plan. Let's do a little math here. The standard plan is $15.49 per month in the United States versus the ad tier of 6.99 per month. If that statement is correct, that means that the advertising dollars coming in, Chris makeup, at least $8.50 per member. That is way more than I expected. They seem to be absolutely killing it on the ad tier right now. I appreciate the KGNS, but I also think Netflix can celebrate a little bit here. They have taken to advertising like ducks take to water.

Chris Hill: You want them to be cagey, don't you?

Tim Beyers: Absolutely.

Chris Hill: This is not an area where you want management to beat their chest and to victory before anything is over. One thing that I think happened at the beginning of this week, a show that I've never watched, a show I'm only aware of because of Twitter and the people that I follow on Twitter, a show called love is blind and apparently there was going to be a live union show of love is blind, and it did not go off as planned. There were technical problems and I'm not a shareholder, but I appreciate the fact that they owned that on the call. They basically, yeah, we need to get better. I think for anyone who's a sports fan and wondering about Netflix getting into live sports. That's the thing that I just look at it and go, OK they're not there yet.

Tim Beyers: They're not ready for it yet.

Chris Hill: I think that that's fine. They got enough other things on their plate. They don't need to worry about live sports just yet.

Tim Beyers: Yeah, and not to get into too much technical geek hurry here, but let's just put some framing around it. Netflix built its own content delivery network for its members and it did that at a time when there just wasn't a good subscription alternative for them to say like, hey, we want a broadcast content around the world and we want to be incident about this. They basically put computers around the world and other people's data centers and said, we want to make it so that there's always a way for us to replicate content. That's really good, Chris, when you're talking about movies, TV shows, pre-recorded stuff that we can roll out and you can be great at that and you can deliver just as well in Hong Kong as you can in Bangor, Maine. I don't know why he came up with Bangor, Maine, but that's what I did. The idea of mastering pre-recorded content is very different from mastering live content and Netflix does rely on partnerships in order to deliver live streams and so, yeah, there's probably some investment and work they need to do to get better at this and you're right, that they owned it. But this is an area of growth for them. I think you're absolutely right. Let's not think that Netflix sees live sports as any an option for them anytime soon. But the pre-recorded market is still absolutely massive, as witnessed by those advertising numbers.

Chris Hill: Netflix always gets a lot of attention from the financial media. But there was something on the conference call that I get the sense you feel a lot of people missed. What was that?

Tim Beyers: There was a moment where Ted Sarandos was making a point that is fascinating but also important. There's a virality in Netflix's content and so the classic case here would be squid game. But we could also take from, let's say the past year, we could take the new series Wednesday, which was just an absolute blowout hit on Netflix and when a Netflix hit goes viral in a territory, then it spreads to other territories at essentially a 100% incremental marginal benefit so as Squid Game appears in Korea, it comes to the US. It draws in subscribers at the US and the cost to acquire those subscribers who are coming in to say, I got to see this Squid Game thing is essentially zero. The contents are already made. Those subscribers come in, they start paying for Netflix, and they've come in on the basis of an investment that Netflix has made in a foreign territory and gotten quite a lot of mileage out of. This happens all across the world. Wednesdays a massive hit here. It may be drawing members in the UK or in France, or in Canada and so on. There's a lot of multi-territory Netflix content that feeds growth in those territories, that feeds the entire growth model overall. I'm not surprised that we're seeing Netflix say, yeah, we think that we can maintain 18-20% operating margins and we probably have room to grow those margins over time. I wouldn't be surprised, Chris, if you look out over a long period of time, that Netflix becomes a really interesting margin story. That's just throwing off mountains of free cash flow because of this dynamic.

Chris Hill: One thing that may help slightly on the margin front is Netflix's announcement with their first-quarter results that on September 29th of this year, they are officially shutting down the DVD part of their business. This zip for the DVDs.

Tim Beyers: I salute your red envelope. I salute you the great and glorious red envelope that those of us who are old enough to remember used to love getting those red on, but Chris, we could admit it. We used to love getting the red envelope in the mail.

Chris Hill: In all seriousness, here is one part of the DVD business that I think is an opportunity for some streaming business, possibly multiple streaming businesses. But whether it's Netflix or something else, it's the bonus features. It's the bonus content that you got on the DVD. It wasn't just that you got the movie.

Tim Beyers: Absolutely.

Chris Hill: You could get behind-the-scenes stuff, and that I hope some business, whether it's, Ted Sarandos and his team at Netflix, someone give us a little bit more bonus feature.

Tim Beyers: I love it. I think you may see this. We're certainly seeing this. There's some interesting data on this. In the US, Netflix is Number 2 in terms of streaming engagement behind, it'll surprise no one, Netflix is 7%, YouTube is 8%. One of the things that YouTube has been doing, it's become a place for bonus content, Chris. Like Jimmy Fallon and The Tonight Show has been doing the between the commercials outtakes and just putting them up on YouTube and sometimes they're absolutely hilarious. I think you're right. I would love to see Netflix do it. It's sad that we used to get that through the great and glorious red envelope, which goes away at the end of the year. It'll be an interesting but sad time when it ultimately happens.

Chris Hill: Tim Beyers, always great talking to you. Thanks for being here.

Tim Beyers: Thanks, Chris.

Chris Hill: You can find stock ideas almost anywhere, like a nearby gas station. Asit Sharma and Ricky Mulvey take a closer look at a beverage company that's returned more than 110,000% so far this century and where it could go from here.

Ricky Mulvey: The best-performing stock of the 21st century is a Monster in its closest competition is not even close. Asit, Monster Energy, Monster Beverage, has made more than 110,000% return since the year 2000. It's close competition, Old Dominion Freight Line looking shabby at a 31,000% return. One escapable mathy part for that eye-popping statistic, it's a good headline, is that Monster started as a penny-stock. Now it trades at about 53 bucks a share. But besides that mathy part, what do you think made that gravity-defying rise possible?

Asit Sharma: Well, Ricky, I think we can't overlook your math and you're absolutely right. This is a company that you had to get on early. Started out as the Hansen Beverage Company. I believe it's the early 20th century. Grew by leaps and bounds selling lemonade and other natural beverages, but by the time the '80s hit, company got in trouble, went into bankruptcy, was acquired by another company in 1990 and from then on, the slow arc began, which just kept accelerating as we crossed into the 21st century. A lot of things went right for Monster. They were in the right place in the right time with an explosive market, the market for energy drinks. They made a fateful decision in 2002 to nearly double the size of an 8.3-ounce energy drink. They came out into the market with a 16-ounce can. People went bonkers over that. Their packaging, the whole ethos of Monster was another great decision. They moved from a direct store delivery model, which really focused that energy business on convenience stores and retail stores into a bigger model through an agreement with Cokes that helped them scale as Coca-Cola Company took over their distribution just a few years ago. We should say they have two incredible relentless innovator/executers, I'll get to that later, in Co-CEOs, Hilton Schlosberg and Rodney Sacks who've been running this company since 1990 when they acquired the Hansen Beverage Company a couple of years outside that 1988 bankruptcy.

Ricky Mulvey: These folks really aren't talked about. Before this recording, I looked up Rodney Sacks, CEO on Twitter, Rodney Sacks Monster, there is exactly one tweet about him. On YouTube, he has done one interview that I'm aware of. It was some conference in 2017. If you look at their earnings calls, there is really no discussion. It looks like a robot or an AI program wrote what they should be saying.

Asit Sharma: True, Ricky. That is the execution side of this innovation/execution framework they have going on. Innovators because they took this fledgling idea, really understood branding, how to appeal to young demographic, ran with it, were able to cut deals for distribution along the way, but so execution-oriented as to be screamingly boring, as to make you cry if you happen to be a person who has to cover those calls, which at one time I was in an earlier life for the Motley Fool. Why those conference calls are so boring is because Rodney Sacks will read out every last bit of market share they have in every region and it seems like they do this for every beverage that is in their wide portfolio. They're doing this for a reason. They're trying to educate the analysts who cover the company on how they run the business, which is extremely methodical. It is looking for those very small percentage point increases geography by geography, which builds this picture of how they see this as a battle from convenience store to convenience store, from warehouse club to warehouse club, to fight for the market share against a wide swath of competitors. Also, I think they're early on figuring out the lifestyle brand stuff along with Red Bull and they're very specific about it. They're not going to sponsor MLB, they're not going to do NBA. They're doing NASCAR, Motocross, UFC, those big high-impact energy events, but you wouldn't know it from hearing their CEOs talk about the business.

Asit Sharma: True. That might be due to Red Bull having the big aha to get into F1 sponsorships, but certainly Monster has also piled up with a lot of very aggressive sports sponsorships. It's a fun brand. It still is a fun brand after all these years.

Ricky Mulvey: The Macho Macho Man, Coca-Cola owns about 20% of Monster Beverage. I think Monster did that for mainly distribution reasons, but how has Monster managed to stay independent? It seems this would have been a rape acquisition target for those biggie, big consumer goods companies.

Asit Sharma: Well, I think Coca-Cola or the Coca-Cola system has a lot to do with this now. I think of Keurig Dr Pepper as being a natural acquirer of this business, would have a great fit between the two brands, but this is a company now that is reliant on Coke's distribution system and KDP makes its money by getting brands to come on its distribution system, so that's not going to work. You think about larger consumer goods companies, why wouldn't diversified conglomerate want to buy this company? I think they do, but here again, Monster has only been exacerbating the Coke ownership because it's been buying back shares. When the deal was first closed, I think Coke's ownership percentage was somewhere between 16% and 17%, and Ricky, as you point out, it's now closer to 20%. Anyone who comes in has this big behemoth of a partner. How do you make decisions with Coca-Cola if you think maybe the distribution isn't going so well here in Eastern Europe? Who are you going to tell to tweak that? You don't have much say there. Maybe there's some hesitation there among the big multinationals to be a partner with Coca-Cola.

Ricky Mulvey: Well, I would also imagine Coca-Cola would have been more than happy to grab more than 20% of the company.

Asit Sharma: For sure. I mean there's a long history between these two companies. Coke tried to start its own energy beverage business. The two have been in litigation. I think Coke's best plan if they could have would've been to just acquire Monster outright, but that wasn't an option at the time.

Ricky Mulvey: Looking at this company, I generated two takes that I'm going to run by you, the first of which is, if you're looking for companies to invest, and it's not a bad idea to find ones that hit the stimulation button, whatever that may be, companies that make addictive products are often really good investments. I would add, with the exception of gambling companies.

Asit Sharma: I'm on board with this idea, Ricky. We can look at Starbucks. We can look at the privately held Mars Corporation, which is a huge candy bar concern, can't invest in it, but these are great examples of companies which have made billions upon billions out of the principle of addiction. Now these are more innocent addictions than some other substances, but nonetheless, you have your coffee habit, you've got your candy bar habit. That's a lot of cash flow over the years for companies that can scale.

Ricky Mulvey: The 7-Eleven near me closed recently, but I was looking around it a couple of months ago and realized, I think if you just invested in every company you saw there or interacted with there, you'd probably beat the market. Some of those would include Hershey, Coca-Cola, PepsiCo, Monster, Celsius Energy, tobacco companies like Altria and Philip Morris. Let's throw in ExxonMobil if you're getting gas and a beer company like Anheuser-Busch InBev.

Asit Sharma: This idea answers an interesting question. The C-store concept, convenience store concept, this answers the question of what happens at the end of the automotive fuel chain? How can we make it worthwhile to sell gas on a retail basis when the margins are so low? The answer, it's a mix of convenience, as the same applies, impulse, and Ricky, addiction. I want to revisit this basket with you that you've just laid out five years from today. Let's look at the total return of this basket versus the S&P 500's total return five years from today.

Ricky Mulvey: Might have to put it on the calendar so I remember. It is very easy to ask you what a stock did. A little bit harder to ask what it's going to do. What do you think about Monster's future right now? Last year they bought a craft brewing company called CANarchy for $330 million. Those brands include Dave's Pale Ale, Jai Alai IPA. It was owned by a private equity company, so I guess you could call it a business in the front, party in the back. Monster's success is no surprise to investors. It's still a little growthy at about 38 times trailing PE. Does have a 25% return on invested capital, so looks growthy. Those are the two numbers I'm going to throw at you. What do you think about Monster going forward?

Asit Sharma: Well, that premium in the multiple that you talk about, which is also still elevated, even if you look at it on a forward basis, that reflects this formula in the company is looking to grow its revenue by about 10% over the next four years. Free cash flow, same. They want to grow it by about 10%, or this is what the market's expectation is, and earnings per share will fall between 16% and 17%. All of these are compounded annual growth figures. If you analyze them, you get a pretty nice growth cadence. People are still expecting Monster to be very aggressive. Its best brands are going to grow by double-digits. This extension into the beer market is a little difficult because it's a competitive market. It's very fierce, any lift that they get out of this is going to come from combining this current Monster beverage packaging and flavor profiles with a beer or hard seltzer base. If you listen to the conference calls after they get past the very boring parts that we talked about, they're talking up this idea of really monsterizing beer. That's my term for it. Not there's, of course. I would say that near-term, there are some margin challenges and we've seen their gross margin drops several percentage points over last year to year-and-a-half because of supply chain issues, rising cost of commodities, etc. Every company's facing the same challenges who puts out product, but for me, that's not so much of a concern. When I look at the valuation, I'm thinking strategically long-term. You've got Schlosberg and Sacks, both are in their early '70s. The two people who are credited with really understanding this business so well, what happens when they leave? How will they sustain the growth? Who's going to take over? These are the questions that really start to bother me when I ask, can it do anything near replicating the growth that it had? Of course, as you told us from the get-go, that math of this being a penny-stock in early 2000s made it happen, but look, to even grow the stock price by 10-15% a year for the next several years, I'd want to know what that succession plan is.

Ricky Mulvey: We're doing energy drinks plus alcohol now. We used to call that a four-loco, Asit. I want to revisit some of the other names on that top-performing list. I think Ryan Henderson tweeted it out. We got Old Dominion Freight Line. We've got Tractor Supply. Then you got Netflix, Apple, and Intuitive Surgical. Any of those names you want to put the microscope or magnifying glass on?

Asit Sharma: Well, I would love to just look at Tractor Supply for me. I think that's a great example along with Ross Stores which you didn't name but is on that list, AutoZone. These are companies who pin their growth formula very early and they demonstrate that in investing. It doesn't have to be so difficult. If the armchair investor, which I still consider myself an armchair investor, regardless of the amount of time that I spent in this business, can identify businesses which understand that to grow, they need a simple algorithm, they need increasing comparable same-store sales, they need an increasing footprint, so more distribution, whether that means adding more stores. In Tractor Supply's case, building out more of those rural lifestyle destinations. Doing this in markets that are pulling that product forward and having people who are going to stick around and can do these two things at once to keep innovating, keep executing, if you can hold those businesses for a long time. Some of the other things that we always ask people to look for that are just extremely hard, like look for a high return on capital company. There are thousands of companies that have a return on invested capital above 10. How's the armchair investor going to find these companies? It's almost easier to look for these great business models hiding in plain sight and that's what some of these companies on this list have in common. 

Ricky Mulvey: Don't make it difficult. Asit Sharma, always appreciate your time and I'll see you in five years for the gas station plus.

Asit Sharma: Sounds great. Thanks a lot, Ricky.

Chris Hill: 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.