All Eyes on Netflix Results, and the Impact of Rising China/Taiwan Tensions on U.S. Policy 7/18/24

0:01Live from the Nasdaq market site in the heart of New York City's Times Square. This is Fast money. Here's what's on tap tonight. All eyes on Netflix. The streaming giant trouncing expectations for subscriber ad in the latest quarter. Shares well off their lows of the aft hours. What is driving this move? Where do shares go from here? And rising tensions of pressure between China and Taiwan ratcheting higher as U.S. policy in the region hangs in the balance. What could happen if things boil over and what could it mean for the markets? Plus, Domino's doesn't deliver on earnings. The Ethereum trust sinks ahead of an expected ETF approval and D.R.

0:34Horton bucks the Today's downtrend takes the rest of the builders along with it. We've got the details on all those moves. I'm Melissa Lee coming to you live from Studio B at the NASDAQ. On the desk tonight, Zee Grasso, Courtney Garcia, Dan Nathan, and Julie Beal. We start off with Netflix earnings shares. The streaming giant briefly turning positive in just the last few minutes. The company is saying it added 8 million subscribers in the latest quarter, and that its ad-tier memberships rose 24 % from a year ago. The conference call just starting 15 minutes ago or so. TVC's Julia Borson's been listening in.

1:04Julia. Melissa, Netflix shares did drop lower on lower-than-expected third-quarter revenue guidance, despite the fact that the company is starting the third quarter with far more subscribers than expected. We have seen shares make up some of those losses. Now down just fractionally. This after the company reported a big subscriber beat, 8 million subscriber additions versus the 4.8 million estimated. And after a number of quarters of subscriber beats, Netflix warning that his third quarter paid net additions will be lower than the year ago quarter additions, which was nearly nine million. And that was the first full quarter where the company saw the impact from its crackdown on password sharing.

1:42Now, right now on the earnings call, Netflix's ad business is very much in focus. The company announcing that it is starting to phase out its basic ad free plan in the U.S. and France. This after doing so in the UK and Canada, which it says helped its ads member base grow 34 percent sequentially. Netflix saying that it is on track to achieve critical ad subscriber scale for advertisers in 2025, noting that they do not expect advertising to be a primary driver of revenue growth this year or next year, but that they are this all because they are cautiously rolling out and testing ad formats and that they won't have ad supply to reach demand until next year.

2:22Melissa? So, Julia, I know that you and John Fort went over this terminology, but it is confusing to the average person. It seems like it's not a bad problem that Netflix has. It's not a bad problem that it has, but this is a company that's really trying to shift gears. For so many years, they said, no advertising, no advertising. And now they're saying, yes, we want to really double down on advertising. We want to do it carefully in such a way that we're not going to alienate our subscribers. And what they really want to do here is build up a massive ad-supported subscriber base. So they have to be really careful about that.

2:59And that's why they're phasing out this lower cost ad-free tier, because they want those people to shift over to the ad-supported tier, where they're generating two revenue streams and also creating enough inventory for advertisers to really be able to narrowly target people. And that is the real advantage of streaming video advertising is you're not just showing an ad to anyone who's watching a show, but you're really able to reach people based on their preferences. So what they need there is massive scale. Remember, this is a massive international company. And when it comes to the ad supported subscribers, they're coming off of a base of zero.

3:34So they're growing quickly, but it's going to be a while before they have the kind of scale that will enable them to do the kind of ad targeting that they really want to do. And that's what they're saying is going to be a year when they hit that tipping point in 2025. Julia, thank you. Keep us posted on the conference call. Julia Borsten. Dan Nathan, what do you make of this quarter? Yeah, interesting that 2025 is the focus for really having an inflection on ads, because that's also the year that they're going to stop announcing on a quarterly basis their subscriber ads, right? And so there's been a lot of volatility around that over the last few years.

4:05Here's the most important thing to me about the ad-supported model, is that it is right now low single digits percentage of their overall revenue. But if you look at their gross margins and how they've moved higher over the last few years. You know, Julia just said this is very high margin business. So they were 39.5 % in 2022, 41.5 % in 2023, expected to be near 45 % this year. So they're turning on this profitability engine, right? And literally, they're coming off such a small base here. This is great news for them. Also, as they've moved into more live stuff, I think that probably frees up some inventory.

4:39So again, they're probably being very smart about this. They've seen other platforms that have tried to jam lots of ads down your throat, and it's not a great user experience when they do that. Yeah, more than 45 % of signups were for ad tier, which was really interesting, and that they expect to increase as the years progress. Yeah, which I think is really positive for them because when you're looking, the advertising revenue probably isn't going to add to their bottom line until at least next year. And so I think that's where you do have this growth driver that you have looking forward, which is a good thing for them.

5:07Because at a certain point, they've gone from a company who is a high growth, low profitable company. And at a certain point, they're probably going to shift that to lower growth and higher profitability. And at what point does that justify like their higher multiple margin? I think that's what investors really have to grapple with here. But the fact that the advertising revenue is still out in the future, I think, still has some runway to go here. This is a stock that is not immune from large sell-offs. We've seen it sell off. And, you know, when you have to remind yourself, because every time you think of the stock, you think it only goes one way.

5:35But when you look at the chart, it's definitely. Which is what way? Because after the last quarter, the one way was down sharply. Right, right. So one way, exactly. So that's a great point. So one way meaning up. And then when you look at it now, you see these sell offs happen on a regular basis and they take out large chunks of the stock. But what does it ultimately do? Get right back on the horse and run right back up. Dan brings up not not allowing you to hear the subs number again. I think that's kind of an odd thing, right? I mean, is that going to rub investors the wrong way? Well, it already did.

6:08That's why the stock was down last quarter. But it hasn't happened. Yes, it hasn't happened. So the markets shoot first and ask questions later. So they react to it. They sell it off. And then when it actually happens, then it's a different story. But when you talk about live sports or you talk about live events, these are all things where they are definitely the premium. They're outperforming Disney by four to one at the very least on a year to date performance. And when you really look at what they're doing, they've really checked every box. So at a certain point, I can't buy the stock. I love the product.

6:41I will never. It's too expensive? No, no, no. I can't buy the stock. Yes. But I'll never cancel it. So I find myself being ironic when I talk about something that will always take my money, but I won't invest in it to get my money back. Julie Beal, when I first saw the headlines about the ad tiers and inventory and all that, I was worried about the ad market. But it really sounds like the advertising industry wants to place the ads. And so maybe there isn't an issue with the health of the overall advertising industry. It's just Netflix's ability to take on those ads. And so how do you sort of, you know, I don't know, apply that knowledge to some other areas in the market?

7:20Well, I think what's really so critical to understand is that investors are much more willing to pay and get excited about advertising than they are about the ability to predict what's going to be the next hit TV show, right? It's much more an ethereal proclamation to try to figure out what is going to be the next house of cards, the next great hit. And so it is much easier to be able to predict we're going to be able to shove more ads on a sequential basis. And that's really the kind of thing that Wall Street rewards. So I can understand their desire to do that because being programmatic is something that they're very, very good at.

7:54And it's wonderful for them that they have both lots of demand for it in terms of advertisers wanting to be on this platform, but also users that are clearly accepting of this medium. And that is, I think, the big question that they have answered. So it gives investors like me who were worried that there wouldn't really be a lot of excitement around an ad tier some comfort. Is this a good thing or a bad thing for the other streamers with ad-supported tiers? Is it that advertisers all want on Netflix and maybe not others? Or does this show you that the ad dollars exist for these ad tiers in general?

8:31Yeah, I think it's bad for all the others because I think that ultimately it's going to migrate over to Netflix once they present the opportunity as far as they can take the inventory or they have the inventory. I'll just say this about what Steve said about volatility in the stock. And, you know, that post-COVID hangover, you know, from late 2021 to the lows, I think, in mid-2022, this stock lost 75 % of its value. It's pretty shocking to think about. It traded as high as$700 in November of 2021. Now it's back, or was two weeks ago, at$700. If Guy was here, he'd say that is a perfect double top right there.

9:03And if you just look at the valuation, okay, if you can buy into the fact that ads are going to be a big part of this company going forward and you agree that margins are going to go higher, You know, they're expected to have 20 % earnings growth for the next two years, about 12 % sales growth with rising margins. You say to yourself, then you want to buy this stock, you know what I mean, when it's down because it's trading about 28 times this year and about, you know, 24 times next or something. That is reasonable relative to that expected growth. And it did get rejected, to your point, on the double top.

9:32It got rejected almost down to the penny on that resistance up around$700. But if you look in hindsight, it didn't have all of these other levers that they have now. They didn't have the ad base model. They didn't have live streaming sports. They didn't have live events. So there's a lot of other things that you can put into it now where you think it should be worth more than it was. But it's still on a technical basis. They don't care about the story. They don't care about the fundamentals. You look at the chart. It got rejected. End of story. All right. So Steve can't get himself to buy it, although he is a Netflix subscriber.

10:07How about you? Yeah, and we have exposure to it, but it's not where I'm adding money right now, because I do think, like, bigger picture, you're seeing this big rotation of the markets, and I do think there are some lakes to that, which I know we're going to talk about a little later. So it's something I own. I'm not getting out of it, but I don't think it's where I want to add my money to right now, because it is expensive, and I agree with you. I'm not canceling Netflix. Like, I'm not getting out of it, but it's an expensive stock right now. Julie, how about you? Where do you stand on the valuation?

10:31I think the valuation is relatively rich, but I don't think it's egregious, because I do think that they're showing a really solid level of profitability. And if you assume that they continue to have good success with their ad-supported business model, it's just not egregious. There are so many other stocks that I would point to as being really, really expensive. All right. We will, of course, keep you posted on what comes out of that conference call. Meantime, let's get to China. Tensions between China and Taiwan are climbing. China announcing it is suspending nuclear talks with Washington due to ongoing arms sales to Taiwan.

11:04On that, as both Joe Biden and Donald Trump ramp up talk of increased restrictions on exports to China, economist Stephen Roach is considered one of the world's leading experts on China. He is a former Morgan Stanley Asia chairman and is now a Yale senior fellow. Stephen, always great to see you. Thanks, Melissa. Great to talk to you. There was a lot of chatter on trading floors around the country about an imminent invasion of Taiwan by China. How do you view that? I mean, what are the odds of that in your view? Odds of that are extremely low right now. If it came, it would be initiated by China.

11:42They've got major problems with their economy right now. They're just coming out of a very big policy meeting. The agenda has yet to be fully released. But the last thing they want to do is complicate complicate their domestic issues with an external shock like invading Taiwan. All right. So you're saying it's just chatter, which is, I'm sure, a relief here. But, you know, in terms of policy and, you know, the next administration, be it a Democratic or Republican one, are tensions just—do you expect them to be any different? Will they be any more ratcheted up or less so under any particular administration?

12:24Does it matter? Are they destined to go higher? Well, you know, I think it does matter. You have to try to disentangle the two. Biden is more focused on tightening the noose on Chinese technology. And I think the repercussions on chip stocks were more a reflection of what Biden has been talking about with respect to sanctions on advanced semiconductors and AI-enabled chips coming from NVIDIA. Trump is more the tariff man, and his tariff proposal is draconian compared to the one that he unleashed in 2018 and 2019. That would clearly be a negative for China, but is less of a Taiwan threat than the more targeted actions of the Biden administration right now.

13:24So, Stephen, I know that you said it's a very small chance that they would invade Taiwan. But if you look at the timeline, I've seen some interesting stats where they really target 2025 to 2027. So 2027 is the centennial of the PLA. And then once you get to 2035, demographics work against them. So if you had to put odds on a time period, because obviously we could all be wrong and you could be surprised with an invasion. Is there a time period where you think it would happen if it were going to happen? Later rather than sooner. China, there's lots of rumors in the West really focused on the year 2027.

14:06supposedly some intelligence that has captured remarks by President Xi targeting that date. I don't believe that. I think, again, China is more interested in the long game here. They do not want to destabilize still the one country, two systems approach. They are concerned about the new sort of pro-independence bias of the newly installed President Lai. They're also concerned about the pro-independence bipartisan bias in the U.S. Congress. What Trump has said in his Bloomberg interview is, you know, we're not really going to lean aggressively against deterring China from invading Taiwan. Taiwan needs to be able to fund its own defense.

15:12We'll treat it as an insurance policy. They want to pay the premium. We'll protect them. But that does not sound nearly as aggressive as the current political stance in the U.S. Congress and the Biden administration right now. Stephen, so you just mentioned that political stance. So let's put that aside. Let's think about Chinese economic growth. I know that last quarter was disappointing. I think it's expected to be about 5 percent this year. You just said that, you know, they're looking to play the long game. When you think about the long game in China, they have a huge demographic problem, which I know that you're very familiar with.

15:45And over the next few decades, they're supposed to go from 1.3 billion people to under a billion and maybe in 50 years to 800 million. When you think about that in the long game, that makes them probably not the sort of adversary that we might think. But does it increase the chance that they make a move, to Steve's point, maybe in a few years on Taiwan because of that lagging growth? Again, I think if you've got weakness on the growth front, to overreach strategically from a geopolitical point of view is a classic recipe of a declining great power. China knows the great power history very well, and that would be foolish of them to do.

16:28The demographic issues you point to are absolutely critical, like Japan faced 20 years ago. The only antidote to that is for China to boost its productivity. And right now, the productivity story is not good in China. Productivity, total factor productivity is actually declining. And so they've got a pretty serious growth problem staring them for the next several decades. Stephen, always great to speak with you. Thanks so much for your time. Thanks, Melissa. Stephen Roach. So Taiwan Semi would be in the crosshairs of any sort of tensions here. They had earnings. It all looked good. They predicted, you know, an extended prolonged AI cycle.

17:15The stock is flat. I mean, they better say that. I mean, like as far as the quarter. No, I'm just saying as far as the quarter and the guidance they gave, it was not better than like some rosy expectations. So I think it was interesting that the reversal that we saw there. But I think it's a pretty safe bet to say that all the times we want to trade Taiwan Semi or some of these other, you know, stocks that have exposure to China and obviously Taiwan, it's probably not happening anytime soon. It probably should not be on your bingo card as far as you're investing around the world, in my opinion.

17:41I understand that. But there's a difference between knowing intellectually. We know this intellectually that the odds are low. But sentiment can be something completely different when it comes to ratcheting China tensions and the impact on a stock. But wouldn't you think that Tesla would have actually had a really bad day today if this is the day where people were really worried about it? You said, you know, trading desks were talking about this. You know, Tesla has, you know, big exposure there, lots of competition. They rely on them for manufacturing, for demand and rare earth materials. And the stock is up more than a couple.

18:12I agree with the last part of your statement, but I think Tesla is a different story because there's so many other things that are pulling Tesla's price around. You answered the question when you asked Stephen yourself. If you're going to get an invasion, they've really honed in on two years because 2030, the USA has sovereignty in their semi-manufacturing here. So there's only a small window. And then they run out of demographics in 2035. You're assuming everything goes well in terms of building the Intel foundries, et cetera. Building the our ship industry. Arizona, Japan. And finding the workforce needed to staff up all those new ship labs that are supposed to grow out of the desert.

18:54They have to. And, of course, there's going to be things that go wrong. But that doesn't mean I think that China, their weakness on an economic level, actually makes me more convinced that they're going to invade Taiwan, not the other way. All right. So is the trade Taiwan semi or is the trade Intel? tell Julie Beal. Probably around Intel. I think I agree. It's just so difficult to be able to predict these. But I kind of agree with you that if they are in a weaker economic position, that actually gives them more liberty. Right. The nice thing about having such deep trading ties is that it makes it harder to really take this kind of action.

19:31And so when that starts to decouple and get taken away, you have more room for a rogue actor. And I think that's where we're all kind of concerned. But I think in the meantime, there's too much uncertainty for me for Taiwan Semi. And so I think Intuit's probably better at this time. All right. We've got a news alert here on Hawaiian Electric reaching a settlement over last year's Maui fire. Kate Rooney's got the latest. Hey, Kate. Hey, Melissa. Yeah. Shares of Hawaiian Electric are up double digits right now. This is on a report that it's among the firms eyeing a$4 billion settlement over the Maui wildfires.

20:02This would be to resolve hundreds of lawsuits over the wildfire that ripped through Maui last year. Again, this is according to Bloomberg, citing people familiar with that deal. The proposed number appears to be below the estimated capital cost, which is why you're likely seeing this relief rally shares up more than 25 percent. The estimate was around five point five billion dollars, according to some of the damage assessments released last year. The fire destroyed or damaged more than twenty two hundred structures. The majority of those were residential and Hawaiian Electric does operate utility on the island.

20:32Now back over to you. All right. Thank you, Kate Rooney. Coming up, Domino's Pizza can't avoid the annoyed. I don't know what that means. If the S &P is worse for former after a rough earnings print before the bell, we will slice up the numbers next. On the other hand, you're Horton topping the S &P 500 today. A huge earnings print helping this home builder hurry higher. What it means for the space as mortgage rates begin to fall right after this. This is Fast Money with Melissa Lee right here on CNBC.

21:09Welcome back to Fast Money. Shares of Domino's Pizza tumbling more than 13 percent today after this morning's earnings report. The company reporting an EPS beat and revenues in line with expectations, but warning of challenges internationally. Today's move sends the stock into negative territory for the year. See me. See you. Kate Rogers has got the details. Hey, Kate. Hey there, Melissa. You said it. The news weighing on the stock this whole day, sending it down more than 13 percent. as the company temporarily suspended its net restaurant openings due to challenges with its largest international franchisees struggling in both Japan and France.

21:41Now, Domino's did see its U.S. comps driven by transaction growth and growing loyalty redemptions, particularly with its carryout business. Executives continue to note that this is, quote, just the beginning for the U.S. loyalty program relaunch, which is meant to be a multi-year comp driver, saying, quote, today's orders are tomorrow's sales, CEO Russell Wiener told analysts this AM of the program. Now, it also said it saw in the face of consumer spending slowing overall, actually growing orders in both delivery and carry out in every income cohort. That will be the theme broadly of this quarter in the sector.

22:14Consumer sentiment and the impact of value and pricing. There's new data from Placer AI finding that McDonald's, Starbucks and Chili's were among the names who saw a boost in foot traffic from limited time offers as value hungry consumers flocked to check out deals. But then again, keeping them coming back beyond those limited timeframes is really going to be key, Melissa. Back over to you. All right. Thank you very much, Kate Rogers. Was this overdone? There are a number of analysts today coming out saying it was overdone, that the international EPS impact would be 0.3 percent on EPS for 2025, which seems pretty small.

22:49It is. But when you really look at the big picture, we started talking about the stock when it was $18, right? It's had an incredible run. And a lot of that run has exhausted itself domestically. And And now the story is, what is that international growth going to be like? And if you have an international growth miss or an international growth that's not going to be as fast as they otherwise thought it would be, that's what the stock is rallying on and that's what the stock is gaining new buyers on. If you don't have it, you don't have the buyers. Courtney, what's your take? Yeah, I would actually probably say this is overstated.

23:21And I do agree with you, but I think just the move today where I was down like 13 % in a day, specifically on that weakness in France and Japan, I would probably say you're going to see a bounce back from some of that. And I think when you do look at some of the U.S. numbers, actually seeing that they had positive both delivery and takeout orders across all income cohorts is actually good, especially when their competitors are having to do discounts to get people in. So I think there's definitely pros and cons here. I mean, the context, Steve, the premise you're making is that it has been a winner, and so therefore you're looking for that next leg of growth.