All Things Bullish








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All Things Bullish
Yellen in Jackson Hole
Doug Nolan
Still crazy after falling yields
Chasing higher yields, investors pile into risky countries
Iraq, Greece, Argentina and others tap the enthusiasm for high-yielding sovereign debt
WHERE can you find a 7% interest rate on a sovereign dollar-bond? You would have to take a time-machine to the mid-1990s to find such a yield on a ten-year American Treasury. Alternatively, you could slip back a few days to August 2nd and bid for the $1bn of five-year bonds sold by the government of Iraq. The yield was expected to be 7%, but it was trimmed to 6.75% once orders rose above $6bn.
Such eagerness for hard-currency debt from a country still reeling from a civil war shows just how far bond investors will now go to get a decent yield. Oversubscribed issues for risky sovereign bonds have become almost normal. The Iraqi sale came just a week after Greece (whose privately held debt was partly written off in 2012) raised €3bn ($3.5bn) in its first bond sale for three years. In June Argentina was inundated with bids for its 100-year eurobond, as dollar-denominated bonds are known. Sceptics noted that Argentina had defaulted on its debts six times in the previous century, with the most recent such upset in 2014. Egypt, Ivory Coast, Nigeria and Senegal have also placed big eurobond issues this year. None enjoys a credit-rating that approaches investment grade, though the eurobond market is familiar with many of them. Ivory Coast, for instance, issued a bond in 2010 in lieu of unpaid debts. It proceeded to miss an interest payment the following year.
Bond investors are ready to forgive such slip-ups. They do not have much choice. The yield on ten-year Treasuries is 2.26%, not much more than inflation in America. A basket of high-yield corporate (or “junk”) bonds pays less than 6%. Yet despite a long period of low short-term interest rates in America, inflation is still quiescent. So the Federal Reserve seems unlikely to raise interest rates much further. “Investors have concluded that we’re not going to get meaningfully higher yields on safe assets,” says David Riley, of BlueBay Asset Management. In this context, lowly-rated sovereign eurobonds can look appealing. Indeed the weight of money has driven the average yield on such “frontier-market” bonds below 7%, according to Stuart Culverhouse, of Exotix, a broker (see chart).
The appetite for ever-riskier bets recalls the recklessness that led up to the financial crisis, which began a decade ago this week. What is different, though, is the absence of euphoria. Few seem to want to cheer the rally in risky eurobonds. But nor do they want to bet against it.
A common complaint is that rich-world central banks are to blame—for keeping rates too low and for studiously avoiding any action or statement that might unsettle the markets (and make investors more jumpy). Other culprits include low-cost “passive” fund managers and exchange-traded funds, which track a basket of government bonds, such as J.P. Morgan’s emerging-market bond index, known as the EMBI. Such indices are also a yardstick for the performance of many “active” funds, ie, those with discretion over what sort of bonds to buy and how much of them to hold. The growing influence of passive funds makes active investors less willing to eschew a eurobond issue that qualifies for the indices, however unsound, for fear of underperforming.
It is easy to suspect that this episode, like so many before it, will end badly, but hard to know exactly when or how. Frontier-market specialists sense a greater interest in their bailiwick from crossover (non-specialist) investors, also known as “tourists”, who are likelier to misjudge the odds of a default. And the reach for yield could always be stretched even further to local-currency bond markets, which are less liquid and a lot more volatile.
Take Ghana, once a darling of frontier investors, as an example. It is back in favour, as its newish government gets to grips with public finances. Yvette Babb, of J.P. Morgan, calculates that 37% of the stock of Ghana’s public debt is already held by foreigners. The effective interest rate it pays on domestic debt is around 16%. The weight of long-term investors is “substantial”, she says, so the risks of a knee-jerk sell-off are low. But how long before such high yields lure in the tourists?
Surviving America’s Political Meltdown
Jeffrey D. Sachs
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Barron's Cover
The Trouble With Netflix
As Disney goes its own way and Amazon looms, shares could drop more than 50%.
By Jack Hough
. Your Value Your Change Short position launched a video service with niche shows covering sports, cooking, reality contests, social-media celebrities, and more. For now, it’s far from a threat to the runaway leader in subscription streaming, but then, when Netflix was founded 20 years ago this month, it was far from a threat to Blockbuster.
Your Value Your Change Short position
There are two ways to accumulate owned hits: Make them or buy them. Both require copious amounts of cash, and Netflix is running low. This year, it expects to burn through $2 billion to $2.5 billion. That’s a remarkable acceleration from the $1.7 billion last year and just over $900 million the year before. For now, it is financing this spending with junk-rated debt. But its long-term debt stands at $4.8 billion.
HOW HIGH COULD NETFLIX push its borrowing? Struggling Viacom (VIAB) makes investors nervous with $11 billion in debt. And it clears more than $1 billion a year in free cash and owns a major studio, Paramount Pictures, which could be worth more than $4 billion in a sale. Surely Netflix’s lenders will want to see free cash flow by the time it amasses $10 billion in debt. But at its current pace of spending, it might reach that level by the end of the decade, and the consensus view on Wall Street is that it will still be burning cash by then and beyond.
One reason lenders consider Netflix a worthwhile risk is its massive equity cushion in the form of its $74 billion stock-market value, versus $12.9 billion for Viacom. If its borrowing power dries up, Netflix can issue new stock.
There are other concerns. Netflix is expected to report a paper profit of $1.17 a share this year, up from 43 cents last year. That number, however, is highly dependent on how Netflix treats what it spends on shows for accounting purposes—and its treatment appears aggressive.
FOR EXAMPLE, NETFLIX CANCELED a show called Bloodline last year after three seasons.
A common practice when that happens is to write off remaining costs, reducing earnings.
Instead, Netflix is holding a chunk of Bloodline’s costs on its balance sheet. Its reasoning is that because the show is still available for streaming, it’s still a going concern. Contrast that with Time Warner’s (TWX) HBO unit, which took write-downs after canceling Vinyl last year and The Brink the year before, even though both can still be found on the streaming service HBO NOW.
The gaping divide between Netflix’s free cash flow and its paper profits, pegged at more than $2.6 billion this year, suggests investors might not be fully aware of the company’s costs. It shows $13 billion in content assets on its balance sheet, including $9 billion in longer-lived content. To put that in context, Disney (DIS) paid $7.4 billion for Pixar in 2006 and $4 billion apiece for Marvel Entertainment in 2009 and Star Wars–owner Lucasfilm in 2012.
THE LOOMING DISNEY DEPARTURE is troubling for Netflix. There’s no way to tell how much of Netflix’s streaming comes from Disney content. There are popular movies like Moana, Zootopia, and the Star Wars spinoff Rogue One, and a deep roster of Disney Channel shows. A day before Disney’s announcement, Netflix said it was buying comic-book concern Millarworld for an undisclosed sum. Netflix can always find more content to license, but increasingly, that will require fierce bidding, because many of the best content owners already have deals with other streamers. 21st Century Fox, Universal Pictures, and Warner Bros. deal with HBO; Lionsgate, MGM, and Paramount go to Epix; Showtime gets hits from CBSCBSA in Your Value Your Change Short position (CBS) and Miramax; Starz has Sony Pictures Entertainment.
Netflix is a so-called FANG stock, a member of a select club known for explosive top-line growth and permission from investors to invest richly rather than maximize current profits. The others are Facebook (FB), Amazon.com(AMZN), and Google, now Alphabet GOOGL(GOOGL). But look closely, and one of the FANGs appears toothless. Facebook and Alphabet benefit from powerful network effects, and already generate massive sums of free cash, a number that’s expected to approach a combined $70 billion a year by 2020. Both have identified video as a main target of future investment.
Investors may not care that Netflix could one day take a big charge to earnings for past show costs, because earnings aren’t central to the stock’s story. But growth is, and investors will care in a hurry if membership gains slow or stall. Growth depends on content, and for companies that don’t own much of it, content requires cash. Netflix runs the risk of getting shut out of attractive content in coming years if its buying power wanes.
In last week’s cover story, Barron’s outlined a similar problem facing TV networks, which could one day face bidding wars with dot-com giants for sports rights (“TV’s Sports Problem,” Aug. 5). The networks hold stronger hands than Netflix, since they own content and generate plentiful free cash. Shortly after our story appeared, Disney and CBS announced they had sports streaming services in the works.
A NETFLIX STREAMING SUBSCRIPTION COSTS $7.99 to $11.99 a month, depending on the picture resolution and number of screens allowed. Prices could push higher, but to generate enough cash to make sense of its stock valuation, Netflix might have to charge at least $20 a month, grow its subscriber count to 150 million, and bring spending under control—unlikely, given that its menu of content could become less compelling, not more. There’s always the possibility of a takeover, and having seen some doozies over the years, we can’t rule that out.
But only a handful of media players can afford Netflix, and no company on earth can squeeze more economic value out of it than Disney. The fact that Mickey is walking speaks volumes.
A Netflix spokesman says no one vendor accounts for more than a few percentage points of viewing; that its free-cash deficit is due largely to the cost of self-produced shows and films; that it doesn’t sell its service below cost; and that companies can burn cash for long periods and still be successful.
Netflix co-founder Reed Hastings once attributed its market-leading stock gains to “momentum-investor-fueled euphoria.” That was in a shareholder letter nearly four years ago, when the stock was $51 a share. He was right then, and he’s even more right now. Our advice for readers is to enjoy the streaming service while it’s still a bargain, and to stay well clear of the shares.