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The pots of gold at the end of the rainbow

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The pots of gold at the end of the rainbow

Letter # 95 | The pots of gold at the end of the rainbow 

There is interesting Irish folklore that resonates with what is transpiring in markets these days. On 17th March each year, at many places around the world, people celebrate Saint Patrick’s Day. St. Patrick is a patron saint of Ireland and people celebrate the day with religious services, parades, big meals and even bigger parties.

Decorations usually include green four-leaf clovers, a small plant said to bring luck, and the leprechaun, a trouble-making creature in Irish folklore. The story goes that when Vikings invaded Ireland in 795 AD, they looted gold and treasures and buried them at undisclosed locations. When they left the shores of Ireland, they inadvertently left some of it behind. According to legend, leprechauns found the abandoned gold and buried it again so that no human could ever find it. It is believed that those pots of gold are to be now found where the end of the rainbow touches the earth.

Folklore can sound silly, but that is exactly what seems to be going around with the video streaming business these days. Last Friday, Warner Bros Discovery (WBD) reported its first combined (post-merger) financial report that disappointed the street with USD3.4 billion in quarterly losses; its shares fell over 16 per cent in trade. Chief executive David Zaslav blamed media houses for their “spend, spend, spend and charge very little” approach to the subscription streaming business. WBD ended 2Q with 92 million subscribers but reported USD560 million combined Pro-forma streaming loss.

Nevertheless, by FY25, WBD is hopeful of having over 130 million subscriptions and expects to post over USD1 billion in EBITDA. And WBD is not alone in looking for pots of gold at the end of the rainbow. How did we get here though?

Since the dawn of film-making, the major US studios have dominated both the American and global cinema industry. They were the first to industrialise film-making and master the art of mass producing and distributing high-quality films. Today, the Big Five major studios (Universal, Paramount, WBD, Walt Disney and Columbia) distribute hundreds of films each year and collectively command approximately 80-85% of US box office collections.

While movie distribution through cinemas was chugging along well, things were about to get shaken up. Streaming debuts as proof of concept came up in the early 1990s when music band Severe Tire Damage first live-video streamed its performance in June 1993. That was early; in comparison, YouTube was launched in April 2005 and Netflix got in on the streaming game only in January 2007.

Netflix has found wild success in streaming and since then, every major studio has jumped on the bandwagon. Compared to 221 million Netflix subscribers, Amazon has 175 million, Disney 138 million, WBD 92 million, HBO 77 million and Paramount 23 million.

While the 2022 Oscars will forever be defined by the headline-grabbing slap, Apple made history by becoming the first streaming service to bag the Best Picture Academy Award.

And how big is the “spend, spend, spend” market? The top eight US media groups plan to spend a whopping USD115 billion on new movies and television shows this year. Disney is by far the biggest,  with close to USD25 billion in content spending. WBD spends around USD20 billion, NBC USD18 billion, Netflix USD17 billion, Viacom USD15 billion, Amazon Prime USD9 billion and Apple USD6 billion. How far have they come? Netflix a decade ago had a budget of only USD1.7 billion; it has grown 10 times in ten years.

The pot of gold is this: Every quarter starting September 2014 until December 2019, Netflix reported a negative free cash flow, peaking at a negative USD1.6 billion in December 2019. In June 2020, that turned positive to USD900 million, rising to USD1.2 billion in September 2020 before falling to USD800 million again in March 2022 as the pandemic eased. If Netflix can do it, so can we. Or so the thinking goes.

Now, these offer interesting lessons for markets. For starters, excesses happen not just with human emotion and markets, but also with companies that spend billions of dollars each year. It happened with the huge global undersea cable capacity creation in the early 2000s, the excess Indian power generation capacity created by 2007, or the surplus cement capacity that gets created practically every year. That, in turn, creates cycles. It starts with the euphoria of something new, which eventually sucks in even the best. Everyone else is doing it, why shouldn’t we?

That business cycle gets exacerbated when the interest rate cycle collides with it. In an easy liquidity market, capital flows in easy. Maybe it even chases companies, in turn forcing them to make multi-year cash flow commitments that come to haunt them when the liquidity cycle turns.

As investors, we will likely benefit if we start recognising these cycles. A two percentage point increase in interest rate might not sound like a lot, but when a bad business cycle and rising interest rate cycle combine, even the best-run businesses can collapse 70-80% (as I had previously written – Note 1). Eventually, if we manage to preserve capital in the market down cycles, we stand a much superior chance of generating superior returns in the market up cycles.

Note 1:


Information in this letter is not intended to be, nor should it be construed as investment, tax or legal advice, or an offer to sell, or a solicitation of any offer to make investments with Buoyant Capital. Prospective investors should rely solely on the Disclosure Document filed with SEBI. Any description involving investment examples, statistical analysis or investment strategies is provided for illustration purposes only – and will not apply in all situations and may be changed at the discretion of the principal officer. Certain information has been provided and/or based on third-party sources and although believed to be reliable, has not been independently verified; the investment managers make no express warranty as to its completeness or accuracy, nor can it accept responsibility for errors appearing herein.