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Dublin: 10 °C Saturday 22 November, 2014

Damien Kiberd: Why middle-aged men with money invest in Netflix…

…And why their tech confusion means there is no logic in how they price its shares.

Damien Kiberd

WHY ARE SHARES in Netflix, the DVD and streaming company, trading at altitudes that might best be described as Himalayan?

Netflix shares closed 2013 at $368 each, posting a gain of just under 300% for last year. Despite historically confused pricing policies in which management showed complete uncertainty about how to charge for it is services, scaring away millions of customers en route, Netflix shares have quadrupled in value in a single year.

Streaming film content into your home or office does not require cutting edge technology. Netflix therefore faces a growing list of competitors, including cash rich Amazon, in streaming as well as DVD. The profit margins on its business are being driven relentlessly down towards zero, having hit almost 10% at one point.

So why has it beaten all other major stocks? Why is it posting a gain that is almost ten times the spectacular 33% increase posted by the NASDAQ 225 for 2013?

Clearly there is far too much money on global stock and bond markets chasing far too few good investment opportunities. This drives share prices to crazy levels.

Asset price bubbles

The era of asset price bubbles has not gone away. If anything, the next wave of junk bond finance, bond securitisation and collateralised debt obligations will be scarier than anything seen in 2007/2008 when Bear Stearns and Lehman crashed.

But there’s a much bigger issue at play. The vast cash piles on global markets are still controlled largely by mentally unquestioning middle-age males who don’t understand the businesses in which they invest. Quite often, there’s no rhyme or reason to what these men do.

These guys don’t really understand the changes that are underway, especially in social media. They have the money to pump up shares in the likes of Facebook (plus 107% last year) and in Yahoo (plus 101%) the latter of which is essentially a play on a Chinese e-commerce site called Alibaba. And they just love Netflix.

Getting excited watching House of Cards

Source: House of Cards via Netflix

Perhaps that’s because they have just enough technical savvy to stream for themselves Netflix’s not-for-TV TV series House of Cards into their own Macbook Airs. They can get excited watching back-to-back episodes of the Emmy award-winning series in which disingenuously metrosexual congressman Frank Underwood (Kevin Spacey) plays the modern Machiavelli of Capitol Hill.

They understand Netflix. They love Netflix, even with its withering profit margins. They buy its shares even at prices that can never be justified by any well-grounded set of forward financial projections. And the wiseguys will take their profit before this contradiction becomes apparent.

Elsewhere, the thinking of the middle-aged men with the money is arguably even more muddled.

When it comes to comparing Facebook and Twitter it’s a case of four legs good, two legs bad on Monday. But then it’s two legs good, four legs bad on Tuesday.

Experts contracting their analysis

Facebook lost $16bn of its value at Halloween after sectoral experts claimed it was turning off teenagers. Many teens were ‘too embarrassed’ to be seen near Facebook, it was said. In the long term, Facebook would be dead in the water. Ergo sell Facebook, buy Twitter.

Later the same experts contradicted this analysis entirely. They said that only a fifth of adults used Twitter compared to 70% for Facebook. Adults had money, teenagers were always broke. Therefore the experts insisted Twitter shares should get a pasting. Ergo sell Twitter, buy Facebook.

Twitter wobbled slightly in November and December, closing at $64 a share after peaking at $74. But since its IPO it has doubled in value despite all the hand wringing about penniless teens.

Who is using what site = hugely important

The argument about who’s using what site, and whether or not they’re teenagers or adult, is hugely important.

Some years ago MySpace got a reputation as the online home of self-regarding musicians and angry teenagers. The markets decided its time was up. Those with any memory left in their cranial hard drives may recall how the marketing experts at MySpace responded with some brilliant flashes of self-deprecating wit. They dispatched teams of MySpace zombies to social media conferences to relaunch their ailing business. They could run but they couldn’t hide.

myspace

In the world of old media, newspaper proprietors used to say that today’s paper was tomorrow’s chip wrapper. You were only as good as your last story. Behind all the bravado, however, they thought it would not get that bad, and that they would all survive. But they won’t – at least not in their current form.

The newspapers that have developed first-class websites where the content differs entirely from the content of the host newspaper, and which can act as standalone profit centres, may have a fighting chance. And that’s only if their management are not muddled about pricing policy and know how to monetise their online product.

The Snapchat cautionary tale

Predicting tomorrow’s winners is not easy. Just when the cash-rich male investors are getting confident about some new site or new concept they get a sudden warning of dangers that lurk in places they don’t understand.

Last week’s hacking of the names and phone numbers of 4.5m users of Snapchat is a case in point. This was, and may still be, a business with a glittering future. The owners of this business have apparently turned up their noses at offers north of $3bn for their shares. But ironically they were unable to protect the privacy of their users on a site whose unique selling proposition was its ability to make exchanged images disappear after a short time interval, precisely so that the privacy of the exchange might be assured.

Whether the financial self-confidence of Snapchat’s top brass will prove justified remains to be seen.  But they know that there are vast amounts of investment capital out there looking for a home. And that the people who control the money frequently haven’t got the slightest clue what they are buying into. Their bet may pay off.

At ground level the tech pioneers are ploughing on: start-ups proliferate frequently with very fancy valuations. And the whole tech/new media sector is breeding a group of sympathetic philosophers who are trying to put it all into some historical context.

In California they’re dusting off the tomes written by Ayn Rand, the demented Russian émigré who wound up living on welfare in the land of the brave and the home of the free. The precepts of her ‘philosophy’ of Objectivism have resurfaced and some of the new wave thinkers are talking about sloughing off the suffocating power of the state in its eternity and, once again, doing a Galt and going to the sea.

The conundrum

But are businesses that seem to reject conventional measures of financial performance – such as earnings per share, annual compound revenue growth, return on equity, discounted cash flow forecasts – capable of imposing new and alternative paradigms on the developed world and its financial markets?

Can you go on attributing vast values to businesses that don’t even know if it is technically possible to sell their product or service? And if exciting start-ups are swallowed up by more conventional businesses like Yahoo, business that has a direct line to the middle-aged schoolboys with the loot, then will the spirit of innovation be crushed?

Certainly there is no shortage of self-confidence, some would say intellectual arrogance on all sides. The men with control of the cash are one issue that won’t go away soon. Their swagger won’t be stemmed by last year’s stellar returns on stock markets which will give them even more firepower. The Dow rose 25%, the S & P by 30%, the Nikkei by 57% and even our own ISEQ by 35%.

But across the road from men with big money are men (yes, mostly and sadly men) with big ideas. Will the creators of Twitter and Facebook be awarded a place in history alongside the men who invented the telephone, the motor car and the jet aircraft?

The Himalayas of tech share trading

But let us return to the Himalayas and the altitudes at which tech/media tech shares now trade.

Those who have climbed at high altitude know it is the most glorious pursuit. But they also know that at the highest levels a single small mistake can bring destruction. Make that mistake and you are suddenly immobilised. The last of your body heat disappears through the pores in your head, your joints seize up, your strength withers away to the point where even a square of chocolate gives you the biggest hit you’ve ever got in your life. And if you don’t somehow get moving your fingers and toes begin to fall off. And you will lie down and die.

Read previous columns for TheJournal.ie by Damien Kiberd>

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