Research Notes: Stocks In The News

Thoughts on streaming, de-SPACs, CrowdStrike and TSLA (again)

📍 TLDR

• News at AMC Networks highlights the risk to media stocks — even Disney.

• The rally in TBLA might not be as crazy as it seems.

• Rumors of a Talkspace buyout seem likely to have echoes in a number of other newly public stocks.

• Still short TSLA - and still nervous about it.

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Call us unconvinced that the equity market has found a bottom. The rally of late has been solid. After a monster day on Wednesday, the Russell 2000 is up 13% since the beginning of October. But the more negative mid-term scenarios we highlighted previously remain in play.

We’re not in the business of making macro predictions but, nor are we going to ignore the external environment. As a result, our strategy of late has been to focus heavily on valuation, look for reversions to the mean, and stay nimble. That in turn means keeping more of a focus on market news than usual. This is not an environment for “set it and forget it” investing.

That strategy paid off of in our long call on Chart Industries GTLS 0.00%↑ last week. GTLS is up 13% since, and to our eye has plenty of room to keep running.

We don’t see another hugely attractive quick-hit opportunity at the moment, but it’s worth covering a few news items from recent days that caught our eye:

AMC Networks

It was our belief that cord cutting losses would be offset by gains in streaming. This has not been the case.

That quote comes from AMC Networks AMCX 0.00%↑ chairman James Dolan in a memo to employees, as reported by the Wall Street Journal this week. But it’s also a quote that seems to capture the risk to the entire industry at the moment.

Not that long ago it was investors’ belief that cord cutting losses would be offset by gains in streaming, and not just for AMC. Disney DIS 0.00%↑ hit an all-time high early last year, and other content providers too posted strong rallies. AMCX itself was above $60 around the same time, and cleared that level again in the middle of the year, despite the obvious (and painful) hit to profits from the impending end of The Walking Dead. The stock now sits at $20.

It’s tempting to assume that AMC’s problems are just AMC’s problems. CEO Christina Spade this week resigned after less than three months on the job. That resignation seems sudden, to put it mildly. Even on an interim basis, AMC doesn’t yet have a replacement lined up. AMC is structurally different as well. No major media player in recent history (and perhaps in all of the industry’s history) had as much of its value tied up in a single franchise¹ as did AMC with TWD.

But if you go through the major streaming players outside of Netflix NFLX 0.00%↑ , the continuing reliance on linear networks is almost terrifying. AMC doesn’t break out streaming profit, but in Q3 its subscriber base increased 44% year-over-year and its revenue fell 16%. For Disney, in FY22, linear networks operating profit was $8.5 billion. Parks ($5.1 billion) and consumer products ($2.8 billion) combined didn’t reach that level.

At Warner Bros. Discovery WBD 0.00%↑, in 2021 (on a pro forma basis) the Networks segment posted Adjusted EBITDA more than four times that of the Studios business. For Paramount Global PARA 0.00%↑ through the first three quarters of 2022, Adjusted OIBDA (another name for Adjusted EBITDA) in TV Media was $4.16 billion; in Filmed Entertainment $185 million.

If Dolan’s judgment of his company (that streaming profits won’t replace linear losses) can be applied more broadly, then the sector is in trouble. Full stop. Yes, the stocks are cheaper, and cheap when looking at earnings that excludes streaming losses. But they’re not that cheap.

WBD, for instance, trades at 6x the ~$12 billion EBITDA figure it’s “working toward” (per the Q3 call) for 2023. That guidance seems questionable given the business’s history of disappointment going back to its days under AT&T T 0.00%↑.

That aside, given leverage and the reliance on declining networks TNT and TBS, that multiple doesn’t necessarily look low enough. Yes, HBO is in the portfolio, but the TNT/TBS business model of syndicated, ad-supported reruns is completely obsolete in an on-demand world. (AMCX, with less leverage, trades at ~3.5x this year’s EBITDA, which it refers to as adjusted operating income.)

PARA is at a bit over 4x this year’s OIBDA/EBITDA excluding streaming losses. The billion-dollar sports rights deals for CBS that run into the next decade look like potential anchors, and if its streaming effort only recoups, say, half of TV Media profits over time, the stock is looking at an ~8x multiple to normalized earnings that don’t arrive until years from now.

For AMCX, meanwhile, there’s a real question as to whether the company will even be able to repay its $2 billion in net debt, even off a 2022 EBITDA base of ~$800 million or so. It will require a sharp strategy shift as well as cost-cutting to manage coming declines. The company to this point has made a clear choice to buy back huge amounts of stock instead of deleveraging. Seven years ago, the company had $2.4 billion in net debt, and 72.4 million basic shares outstanding. It now has $2.06 billion in net debt, and 43.0 million shares outstanding.

So is Dolan’s diagnosis of AMC applicable to the wider industry? It looks like it might be. One perhaps underappreciated part of the linear model is how much consumers spent on channels they never watched. Disney’s ESPN was the biggest beneficiary of this model, getting $10-plus per month in affiliate fees from millions of Americans who didn’t even like sports. But ESPN was far from alone.

Obviously, we’re all still paying for content we don’t watch — no one on Earth can catch up on everything streaming on Netflix — but it’s not quite the same. Pricing is much more transparent, and the ease of canceling far higher. The new model does not seem to be as lucrative as the old one was, if only because for those of us who don’t regularly watch sports, the amount spent on content is so much less.

That problem doesn’t even account for the high likelihood that at least one of these platforms is going to hit a vicious cycle and flame out. If revenue lags, the platform can’t invest in content, which leads to negative subscriber growth, which drives even lower content spend, and around and around we go. Yes, Paramount and WBD have huge content libraries, but those libraries cannot be monetized at the levels required.

The question, then, is if there’s still a case for shorting the sector. That might be difficult. I’m reminded of a prescient article on Seeking Alpha from J Mintzmyer in 2015. Mintzmyer perfectly predicted the coming pressures on ESPN (whose subscriber base was in the process of peaking) and recommended a short of Disney as a result. The trade still proved to be just a funding short for years, before DIS soared in 2019 when Disney Plus was officially announced, and then again in 2021 when optimism toward all things streaming was at its highest.

In other words, media bears can be right long-term, but for the short to work the market has to agree they’re right. We’re a bit more confident in the former than the latter.

Disney

Exclude very brief dips during the February 2016 and March 2020 sell-offs, and DIS hit an eight-year low last month. But the pessimism reversed, at least somewhat, on the surprising news that former chief executive officer Bob Iger was returning to the top spot.

Iger replaced Bob Chapek — who, to put it bluntly, had to go. A Parks veteran, Chapek clashed with experienced executives on the media side. As I noted in a Twitter thread back in September, Chapek’s commentary on sports betting strongly suggested he didn’t understand that industry or, more broadly, ESPN itself. That blind spot was something Disney could not afford in the current environment.

All that said, it’s worth remembering that it was Iger who ‘won’ the bidding war for Fox, a business which itself was (and is) heavily reliant on a linear model. And it’s worth remembering that there really isn’t much to do for ESPN, in particular. Affiliate fees are going down, while competition for live sports — the last hope for the linear world — seems to be intensifying as streaming networks get in the act². Even if Iger is an improvement over Chapek (and it appears that anyone would be), the bear case for Disney is precisely that no executive can solve the intractable problems it faces.

Interestingly, the market does seem to have remembered that fact. DIS gained 6.3% in trading the first session after Iger’s return was announced. Including a rally Wednesday, it’s barely budged since, while the S&P 500 has gained more than 3%.

Taboola

When shares of a clickbait platform that went public via a de-SPAC merger soar 43% on a partnership with Yahoo! (yes, that Yahoo!), investors can make two assumptions:

1. This is very funny.

2. There’s a screaming short opportunity here.

Only one of those assumptions would be correct, however. The rally (now 51% in three sessions) in Taboola TBLA 0.00%↑ is funny (come on, is it 2002?) but in fact it does make some sense.

Based on figures from Taboola, pro forma for the partnership, TBLA trades for barely 3x EBITDA and less than 9x free cash flow. Yahoo! is now owned by Apollo Global Management APO 0.00%↑, which ostensibly provides a bit of a vote of confidence in Taboola given the 30-year (!) term of the agreement.

And while Taboola profits are guided to shrink this year, that’s not terribly surprising given what’s going on in the broader ad environment. Overall performance doesn’t look that bad, with Adjusted EBITDA guided up nearly 50% from 2020 levels, and in fact well ahead of the original projection given at the time the SPAC merger was announced in January 2021. (2021 performance substantially exceeded the projection as well.)

It’s tough to get too excited about Taboola discussing plans to disrupt the “walled gardens” of Big Tech, but even after the huge rally Taboola doesn’t have to do so for the stock to rise. This is an idea that requires more work to get truly comfortable with, but at the very least the TBLA rally is not as crazy as first appearances would suggest.

Talkspace

In another Twitter thread last month, I talked about the story of Infospace, a dot-com bust that eventually became Blucora BCOR 0.00%↑. Infospace wound up with a small business, a ton of cash and a huge trove of deferred tax assets; as a result, the company moved heavily into M&A to acquire profits it could shield from taxation. Though there were missteps, shareholders actually wound up doing quite well in the 11 years it took that strategy to play out.

What makes that story interesting now is that the SPAC bubble is going to leave a good number of companies in somewhat similar situations: enough cash to not go bankrupt, but not enough business to do much more than that. They will have to get creative, and ahead of that point investors should think about doing the same.

At Wednesday's close, online therapy provider Talkspace TALK 0.00%↑ is juuuust on the edge of being a 'net net'³. The company closed Q3 with $153 million in cash, and has a market capitalization of ~$140 million (as reported in public sources). It should finish this year with well past $200 million in NOL carryforwards as well.

But the company is also burning ~$15 million a quarter in cash, and its consumer-facing business simply isn’t working. Revenue in the B2B channel is growing nicely, but at lower margins may not be enough.

TALK stock is up sharply this week amid rumors that Amwell AMWL 0.00%↑ might be interested in buying the company out. Amwell, itself a busted IPO, ostensibly could add Talkspace’s offering to its platform.

From a distance, it’s difficult to gauge how solid the AMWL-TALK speculation is. But after the huge number of IPOs and de-SPACs in 2020 and 2021, there are going to be companies that simply try to salvage whatever value they can, even if that means selling out at less than 10% of peak prices. There are going to be businesses that, like Infospace in the 2000s, look like zombies. There will be all-stock mergers that allow for enough cost savings to give the combined company a chance.

Finding these opportunities will not be easy, and trusting management and particularly boards of directors will be key. But we’re at least getting in range of the point where investors can’t simply write off IPOs and de-SPACs that seem like they’re heading to zero. Some of them may not be.

Tesla

(Author’s note: We wrote just four weeks ago that we had spent too much time on Tesla. We apologize for returning to the topic again; it simply remains a fascinating story in so many ways.)

Even with a 7.5% rally Wednesday, Tesla TSLA 0.00%↑ is down 13.6% since CEO Elon Musk's acquisition of Twitter closed. A key question is why.

It’s not the market: the NASDAQ 100 has rallied 7.5% over the same stretch. And it’s not news flow: Tesla hasn’t had a single SEC filing during this stretch. Events in China may have had some impact, but hardly enough to support 2100 basis points of underperformance against the QQQ.

It’s the Twitter acquisition that has driven TSLA down. And, at least per a Morgan Stanley survey, Musk’s actions on the platform are a key reason why. Roughly two-thirds of respondents said the acquisition will have a “negative or slightly negative impact” on Tesla’s business going forward.

We detailed our short case for TSLA back in June, and I’m personally still short the stock, but there’s some cause for skepticism toward the narrative coming out of the survey. Musk’s Twitter activity seems unwise, to put it mildly. Whatever the merits of his arguments against the “woke mind virus”, or his right to have a pistol on his bedside table, Musk is choosing a political side. That seems likely to alienate both potential customers and current regulators.

That said, it’s also fair to ask if it really matters. Twitter is a bit of an echo chamber. Some customers may boycott Tesla, but that may be offset by increased brand loyalty from a new cadre of Musk loyalists. And a quarter of Tesla revenue comes from China where Twitter is banned (though still used).

Fundamentally, we still believe in the case we laid out in June, even with TSLA down 16% since then. But shorting this stock has never just been about the fundamentals. Sentiment plays a huge part.

Most of the respondents to the Morgan Stanley survey likely believe that Musk’s activity on Twitter is undercutting that sentiment. They may be right — but it’s only possible to believe that if you actually follow Musk’s activity on Twitter. The base of people who do know, let alone care, might be a lot smaller than many of us think. And we’d warn, as we have before, that short sellers dismiss Musk at their peril.

CrowdStrike and The Fed

It was a speech from Federal Reserve Chairman Jay Powell that sparked Wednesday’s rally. On our chat app, subscribers had an interesting discussion of Powell’s comments and what they mean going forward.

Again, in this kind of market investors need to pay attention to macro factors, and the pace of interest rate hikes obviously matters. But, personally, I do wonder whether the continued focus on the Fed is missing another significant problem for this market.

CrowdStrike CRWD 0.00%↑ highlights that problem. CRWD stock fell 15% on Wednesday (the decline was ~20% before Powell spoke) after giving soft guidance for fiscal Q4. But the company still grew revenue 53% year-over-year. Based on guidance, it trades for 78x this year's earnings. Given the long growth runway in cybersecurity and strong incremental profit margins, that fundamental profile seems at least intriguing.

But if you look closer, the fundamentals start to get a little blurry. CrowdStrike is guiding for adjusted operating income of ~$350 million for the full year; it’s booked $375 million in stock-based comp.

Including dilution, full-year operating margins should be in the negative 6% range. Even after the decline, CrowdStrike has an enterprise value above $25 billion. Investors should pay attention to the Fed, certainly. But no matter what Powell does, valuations still need to work.

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As of this writing, Vince Martin is short TSLA.

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1. Remember that AMC does not own its other three big hits: Mad Men, Breaking Bad, and Better Call Saul. The company’s second-most valuable owned property might be Halt and Catch Fire.

2. WBD CEO David Zaslav did say last month, in reference to his TNT network, that “we don’t need the NBA”, which might suggest that competition from linear rivals for rights will moderate over time.

3. A ‘net net’ is a company whose net current asset value (current assets less total liabilities) exceeds its market capitalization. In other words, in theory, the stock trades at a discount to current assets even assuming the company paid off every single one of its bills, current and long-term.