Friday, April 08, 2011

Odds & Ends

I found it amusing to hear Roger Altman, erstwhile Clinton advisor, sing the praises of Warren Buffett on CNBC yesterday morning, despite the recent Lubrizol/Sokol front running/insider trading flap.

The network, I guess to curry more favor with selected guests, and coincide with a golf tournament, has been plastering the title "Market Master" on all manner of financial oldsters for the past week, regardless of whether they ever managed a live portfolio.

Altman was interviewed yesterday, and, when asked, fairly leaped to the defense of Buffett that characterized him as angelic. The superlatives tripping out of the investment banker's mouth made it crystal clear that, by doing business in circles which intersect with Buffett, Altman was not going to say a single negative thing about him. In a business where contacts are everything, you could see Altman had become a shill.

So charming.

In an unconnected story, Netflix, which entered the S&P500 last December, replacing the New York Times, has finally entered my equity portfolio.

For the past few months, I've been hearing CNBC's Herb Greenberg criticize Netflix's accounting practices and equity price. While not recalling all of the specifics, Greenberg's attacks largely centered on content acquisition costs and cash flows. Here's what he wrote a couple of days ago,

"So far this year, Netflix has committed to spend between $300 million and $400 million on new content, including "Mad Men".

If you just look at their balance sheet and cash flow statements you might say: “Not so bad.”

They have about $350 million in cash and about $230 million in debt.

Even cash flow positive, with reported free cash flow of $82 million.

Here’s the problem: In their 10-K, they disclose $1.3 billion in content obligations spread over a number of years, and that’s before these recent deals.

That gets us to their payables, which have been rising to levels not ever seen: $222.8 million last quarter, up from $92.5 million a year earlier. Another way of looking at it: Payables to revenue are 9.35 percent — the high end of its range; it was 5.2 percent in the fourth quarter of 2009.

Adjust the cash flow to reflect the payables and suddenly cash flow isn’t quite what it appears. Len Brecken of Brecken Capital, who has been short Netflix, says that if 2010 operating cash flow of $276.4 million were adjusted for the ballooning accounts payables it would fall below 2005 levels of $157.5 million.

(And this is before getting into his argument that net income is inflated by artificially low amortization of cash content costs.)

My take: Netflix has done an exceedingly excellent job capturing mind share and market share and building a seemingly unbeatable brand."

With the equity now among my selections, I'm no longer a disinterested observer. But Greenberg's arguments are not time-dimensioned. You don't get a sense of when he believes the stock's price will go into free fall.

Meanwhile, Netflix seems to continue to enjoy wide consumer appeal, thanks to its instant viewing capabilities. Yes, I know Facebook and Amazon are competing with Netflix. But there's still the ability with the latter to obtain physical DVDs for viewing material that isn't on demand anywhere. For a fixed price.

If Netflix had more of an opaque profile in terms of what it sold, and to whom, I would take Greenberg's concerns more seriously. As it is, he and other, like-minded critics have been vocally objecting to Netflix's valuation and accounting for several months. That ought to be sufficient time for investors to have factored these stories into their buy or sell decisions. And the firm's equity price has continued to strengthen.

In the past, my equity selections have included Tyco and a few home builders. In each case, my selection process had exited the equity in question long before its price cratered.

I'm not a long term holder of equities. There's a potential for a portfolio to turn over quite significantly after six months. That doesn't mean an equity won't continue to be selected monthly for some time. But each month's decision to include an equity is different than the prior month's. Just last year, Intuitive Surgical and McAfee proved to be disappointments. But  that didn't prevent the strategy from nearly doubling the S&P's gross returns.

So while Netflix is now in a portfolio, its weight isn't out sized. And, honestly, I don't care, presently, where its price is in two years. Or even a year, for that matter. It takes a lot of investors with varied valuation models to make a market. Sometimes, despite a firm's flawed long term strategy, you can make money in the meantime.

No comments: