[00:02:41] Arif Karim: So I think to answer your question, what is it that I think a great business looks like in general? When I think about a great business, to me it’s a business that provides a lot of value to its customers. It’s able to monetize enough of that value to build a business that has high returns on capital, but without squeezing their customers, right?

[00:02:58] Arif Karim: So there’s some sharing of what I call the value surplus between a company and the customer. And then you want a business that can protect its business with advantages that it builds against commoditization of the profit margins, and then it’s able to grow over a long period of time so that you have the ability to compound investments in the business over many years.

[00:03:17] Arif Karim: So I think Netflix has all of those characteristics, right? It provides a valuable service that’s customers, it’s globally applicable, it’s scale, and other characteristics that bring moat aspect to the business. That protects us from competition and protects profit margins ultimately. And we’re starting to see aspect of that play out.

[00:03:37] Arif Karim: It’s things that have been playing out, but it’s really starting to scale now, now that it’s gotten to over 300 million subscribers globally. I think in general, the media business is a business that addresses core human need for entertainment, experience sharing. And what I’d like to think of as a empathetic voyeurism, right?

[00:03:54] Arif Karim: Where you get to live other lives through these experiences. And that’s core to like human nature. I think from a Netflix specific perspective, you know, it really launched its streaming service just as the inner became ubiquitous globally, right? And in the past, traditional media companies tended to be more regional because they were restricted in reaching their consumer audience.

[00:04:20] Arif Karim: With the dawn of the internet age plus mobile, you basically pulled out that restriction of delivering your content via wires. And that allowed it to scale, create this new business media business that scales on a global basis, which I think changes ultimately what the profit umbrella could look like for this business because of that scale and then, and what the returns gonna look like.

[00:04:42] Arif Karim: So we’ll see how that plays out. It’s in the process of playing out and it’s been exciting so far.

[00:04:47] Clay Finck: Yeah, I think for many years they always wanted to reach that scale, and it was in four or five years ago, they crossed profitability on a gap basis. Other than just the scale and the ability to spend more on content than anybody else, what do you think are some of the major factors that play into the moat and competitive advantage that they have over the host of competitors that they have?

[00:05:09] Arif Karim: Yeah, that’s a great question. So obviously scale is an important part of a moat, but they have to build that scale, right? And there’s, I think, other components that went into, you know, what ultimately becomes the scale advantage that it has. With Netflix, I think that you had its culture that was very unique relative to other companies in the industry.

[00:05:30] Arif Karim: Like a set of what I call know-how, you know, capabilities that they built that also gave them the ability to out-compete their competitors in the execution in building that scale. So, I mean, obviously scale is really important in this business because, you know, you could spend a hundred million dollars for a piece of content, you know, whether it’s a series or a movie, and whether you deliver that content to 10 million subscribers or a billion subscribers, it doesn’t change your cost of that content necessary.

[00:05:57] Arif Karim: But the per unit cost, that content changes dramatically, right? You go from, you know, a dollar per customer to maybe 10 or a hundred dollars a customer, depending how many customers you have, right? So the larger scale the better. At this point, Netflix has over 300 million subscribers. And that’s really households.

[00:06:13] Arif Karim: And if you think of every household as being two to three, four people in the household watching, you’re talking about a viewer scale of half a billion to a billion viewers that are watching Netflix. Out of 8 billion people in the world, that’s pretty amazing, right? So to your point, scale is ultimately the ultimate competitive advantage that they were kind of building towards.

[00:06:33] Arif Karim: But in getting there, you know, I think the culture had several key aspects to it. They’ve always had a strong focus on the customer experience, which then allows them to create ways of acquiring subscribers, retaining subscribers, and that’s ultimately the underlying driver of that scale, right? The more subscribers you have, the more revenue dollars come in, the more you can invest in content, the more content you have, the more attractiveness to new subscribers.

[00:06:58] Arif Karim: They come in, you have more dollars to invest in content. So there’s flywheel that’s involved in that, but there’s these other capabilities that they have that what are knowhow capabilities? Are also intimately tied with their culture. So one is that it started as a technology company, right? There’s a strong technology component to it.

[00:07:15] Arif Karim: And so delivering video from their servers to the customer, that’s an important capability that they built out. Initially, they were licensing or paying for third party content delivery networks, but then I think it was maybe in the 2015 ish timeframe, they started to build out their own content delivery network.

[00:07:37] Arif Karim: And what that really means is when the customer plays play wherever they are in the world, you want that delay from pressing play to get you watching the content to be content as low as possible, instantaneous, essentially, right? You want the quality to be high, you want the cost to be economical for the pipes, the ISPs that control that last mile to the customer.

[00:07:59] Arif Karim: So in that, there’s this, all this technical capability, whether it was compression. Security of the content. So it couldn’t be piratey at the time. I don’t know if you remember, but back in the early two thousands and 2000 tens, pirating was a big issue of content. So you had to protect that content. And then there’s the latency issue, right?

[00:08:16] Arif Karim: So like when I first started watching Netflix streaming, I think it was like 2010 or something like that, before streaming was our main business, you hit play, then you wait, there’s a bit of a downloading experience and then the thing comes up, right? And that’s just a suboptimal viewing experience. ’cause you’re just as likely to frustrated, move on kind of thing, right?

[00:08:34] Arif Karim: So that content delivery piece is super important and they built it out themselves. And they built it by growing the scale across different regions that customers would wanna watch whatever the latest piece of content was that was hot. And then it would like overload their ISPs network. And so then Netflix would go to the ISP and be like, oh hey, by the way, let us put a server in, you know, that last mile location where customer is reaching out to download the video to start watching.

[00:09:02] Arif Karim: That’ll take the burden off of you because we know that 10:00 PM in Rio De Janeiro, 80% of customers will watch these a hundred things. What’ll happen is the night before at 2:00 AM when no one’s using your backend pipe, we’ll just download the a hundred things that 80% of customers will watch tomorrow night and that way reduce the burden for you.

[00:09:22] Arif Karim: The ISP from a cost and logistics and operations perspective, and the ISP, let them put their server in. But you have to have a certain scale thing up there, right? And so that sort of thing, you know, nobody else was doing, these guys were inventing this as they were going along, right? What ended up happening was before Disney launched their Disney Plus service, they actually made billions of dollars to acquire something called BAMTech, which had developed a good experience service in Disney Plus service so that they could have a similar type of experience.

[00:09:52] Arif Karim: But anyway, there’s a couple examples of like, you know, these core knowhow detailed things that Netflix learned over like several years and became part of their moat because it makes it harder for the next guy to start something because there’s expectations around content delivery. There’s expectations around how they interact with the customer.

[00:10:11] Arif Karim: I’ll just add that, you know, it’s over time. The cultural pieces that really struck out to me as being important for Netflix’s success are its ability to experiment and learn and then quickly fix mistakes, and that all goes into that kind of ingenuity and adaptability that is at the core of how the company operates.

[00:10:30] Arif Karim: I think those are kind of empirical pieces that we don’t traditionally talk about in terms of moat, but I think they are a moat source in the sense of like the execution that it takes to get to building that moat and then continue to add onto that moat and grow it. So that’s all just, okay keep going.

[00:10:45] Clay Finck: Absolutely. And I think a key piece of what you’re getting out there in that culture is just this focus on delivering more and more value to your users. So when you really think about it, if you’re paying 18 bucks a month for Netflix, the amount of value you’re getting relative to some of these other subscriptions that are similar price, it’s just like, it doesn’t really compare to a large extent.

[00:11:07] Clay Finck: And one of the other things that’s makes Netflix an interesting business to cover here on the show is simply the share price volatility. So from November of 2021 through June of 2022, shares of Netflix fell by 75%. And then now today we’re at near all time highs. Recently it’s come back from a thousand dollars a share.

[00:11:29] Clay Finck: And I would wager that just most investors just don’t have the stomach to hold through such an intense drawdown. So how about you talk a little bit about what sort of sentiment change happened during that time in the lessons you took away from that drawdown?

[00:11:44] Arif Karim: Yeah, that was quite an experience between November, 2021 and through 2022.

[00:11:49] Arif Karim: The stock had its biggest drawdown that I’d ever experienced as an investor. And I personally as an investor, I had experienced in a portfolio stock that I was co-managing. It happened to be our biggest position to boot it as well. You know, when I was at ensemble, it was a difficult period to hit the stock and, and me and our team, but we had built a really deep understanding of the business and conviction in it, the business model, the drivers, the management team.

[00:12:15] Arif Karim: And so we had to go back and reassess all that, that warp that we had done to see if we were missing something. And obviously the market had reassessed what the value Netflix stock was because in that period, their subscription growth, they even had a quarter, I think it was Q2 of 2022. Where they lost almost a million subscribers, and that was the first time in a long time that they had lost a real number of subscribers like that.

[00:12:41] Arif Karim: It’s possible that they had something similar happen back in 2012 when they switched their model from the DVD rental business to the streaming business, but it had been at least a decade. You know, since they had something like that, they had been a growth company for a long time. So, as you know, I mean in a fixed cost business, so here, so Netflix’s model is they invest in content and then they leverage that over their subscribers, right?

[00:13:03] Arif Karim: So if you’re growing subscribers, the model inherently has really great leverage characteristics in that you’re becoming more efficient from a cost perspective, more efficiently deploying your content investment across subscribers. Your profit margin are also gonna go up over time as a result of that.

[00:13:18] Arif Karim: But if you stop growing, then all of a sudden, a, the market reassess what the value of your future cash flows will be, right? So if you can grow 15% a year for a decade, and the market expects that, and then all of a sudden the market reassess your growth rate to near zero or 5%, that’s a huge change in valuation based on the cash, we’ll, we generating in 10 years, right?

[00:13:40] Arif Karim: 15% a year for 10 years is a much, much larger business than growing 5% a year in 10 years. Right? But secondarily, because if you stall growth at the level, at the scale that Netflix was at with the cost structure that it had, you’re talking about a certain level of profitability that generates that cash flow versus growing 15% a year for the next decade and then, or even 10% a year, and you’d be scaling into a higher profit margin.

[00:14:03] Arif Karim: So you have this duality of reassessment. One was the growth got reassessed down and the ultimate profit margin, the margin the market expected got reassessed downwards. You had that double wagging. So at that point you have to reassess how do your, in this case, my how do our forecast agree or disagree with what the market is now saying, which is the majority, right, is saying the outlook’s gonna be, and so you have to ask the question ultimately came down to that stall of the stalling and subscriber growth. Ask the question, why did subscriber growth stall? Is it that the market is mature? Is there too much competition? What’s going on? Right? And the market narrative at the time was that there was so much competition.

[00:14:46] Arif Karim: All these streaming choices. You had Disney plus, you had Hulu, HBO Max, Apple, Amazon are on there too. But what was interesting is in 2020, you know, Netflix had its highest ever subscriber growth, right? As you recall, you know, we were all stuck at home. A lot of people were bored, like a lot of time on their hands.

[00:15:05] Arif Karim: It pulled in a lot of new subscribers right into that year. So we knew that aspect was there. So it was kind of a bull whipp effect where they pulled in subscribers, maybe pulled forward some of the demand that they would’ve seen. That was one aspect of it, and that was playing out through lots of different industries, lots of different companies.

[00:15:21] Arif Karim: But the other was that there was this narrative of competition, and that was one that we looked at it and just thought that was false, that was a red herring. And we’ve kind of seen this before with Apple, actually, but the analogy was very clear. The easy thing to draw on what makes news was, oh, there’s all this competition, right?

[00:15:37] Arif Karim: That’s the sexy narrative of why things fell apart for Netflix, and it would be very much difficult for Netflix to acquire substantially larger numbers of subscribers because they’re sharing these new subscribers with these other streaming services. The problem with that narrative is that content is not fungible, right?

[00:15:53] Arif Karim: If you are a Marvel fan. You’re gonna go to Disney, you’re not gonna find that on Netflix, right? If you’re a fan for, I don’t know, Squid Games, you’re gonna go to Netflix for that, right? You can’t go to Disney for that, right? There’s like a lot of what I call commodity content that you can go to anybody with, and that’s really just a time filler, right?

[00:16:11] Arif Karim: You might be doing something else you want see in the background tradition. That’s what a lot of TV watchers do, but at the end of the day, you decide which service you’re going to subscribe to based on kind of the differentiated stuff that’s drawing you to that service, and so we didn’t believe that there was this competition issue necessarily.

[00:16:27] Arif Karim: Just to go back a little bit, to put you in our frame of mind and how we were thinking about Netflix when we first invested in Netflix in 2016, and we looked at the distribution of subscribers along the service, the US had something like 70 million subscribers already in 2016, and so we viewed that as kind of the mature markets.

[00:16:45] Arif Karim: We weren’t expecting a lot of growth from the US market, but we did expect a lot of growth came from international. That’s where the scaling was about to happen, just for perspective at the time. There were 85 million ish cable subscribers in the us so Netflix already has 70 million subscribers. It had a substantial piece of the population or households, and there’s like 110 million households, a substantial number of households that were already subscribers to Netflix.

[00:17:11] Arif Karim: So you can’t expect high penetration is my point, you know, in the us. But when you look at other places like, you know, EMEA, Asia-Pac, Latin America, it was still under penetrated, massively under penetrated. It was very small. So it was a lot of runway to go and that was our thesis.

[00:17:25] Clay Finck: And for those not familiar, what’s, what’s EMEA?

[00:17:28] Arif Karim: It’s Europe, Middle East, Africa, but it’s primarily the eu, so Western Europe. But fast forward to 20, 21, 22, EMEA had become the strong driver of subscriber growth, new subscribers. You know, it was growing, you know, something on the order of like, it was 10, 12 million subscribers a year. So they were kind of the drivers of subscriber growth.

[00:17:49] Arif Karim: And what we saw happen in 2022. All of a sudden EMEA went from like, call it 10 million subscribers to six and then like zero. And the thing we worried about is had they reached maturity, right? Like we had thought of the US market as being mature, had EMEA reached maturity, Latin America was a market that took off, you know, before EMEA did, that could be mature.

[00:18:14] Arif Karim: And the key question really that you have to grapple with is what does mature mean? Is 70% penetration of household mature is 50, is 80? Where’s that number? And that’s kind of unknowable. But we figured that EMEA would probably look something like the US in terms of maturity, penetration. And it hadn’t reached there in EMEA at that point, and there was a sudden drop off in early 2022 in growth in emea.

[00:18:36] Arif Karim: To us, the obvious answer was not competition, it was the Ukrainian Russian invasion of Ukraine, right? When you have a big power invading a country in your continent, you know right in your backyard. Are you be looking for something to subscribe to for entertainment? Are you gonna be glued to like the news, you know, 24 7?

[00:18:53] Arif Karim: And so that seemed like the most plausible reason why this happened. And that would be a temporary thing, right? At some point we hoped that, you know, things would get better. Russia would and Ukraine reach a cease fire, you know, I mean six months or something like that. It didn’t turn out that way obviously, but people have an ability to adapt their environment over time and go back to like their old habits.

[00:19:12] Arif Karim: And that’s certainly what ended up happening, you know, as the year went forward. But having said that, you know, we also had confidence in the management team. We knew that there are levers that they had that they could pull over time. And the the other thing at the time actually that was also a risk, and we had thought about this, was there was a lot of talk about recession.

[00:19:28] Arif Karim: 95% economists thought there was a recession coming in 2022, right? Because interest rates were going up, inflation was high. That was the other thing. In Latin America, there’s a stalling growth ’cause inflation was much higher than it was here. Netflix was raising prices like 15, 20% to keep up with inflation in Latin America, right?

[00:19:46] Arif Karim: So there were all these different things happening at the time that were most likely to be temporary things that would normalize over time. We didn’t know exactly when, but that was the bet we were making. But on a sort of fundamental basis, we thought that the value that Netflix was creating hadn’t changed.

[00:20:04] Arif Karim: The market penetration was still low enough that growth could resume again. And we knew that if we were right about that, that the market would reassess its estimation of, you know, again, what growth is gonna be like in the future, and what ultimately profit margins look like, which would change how the stock is valued.

[00:20:21] Arif Karim: And at the end of the day, that’s what you have to do. Right. For me personally, kind of as I think about it, there’s lessons learned there, right? I mean, obviously your position sizing has to be in a place where you can comfortably tolerate large changes in valuation that you may not expect to see.

[00:20:37] Arif Karim: But the other is that the amount of conviction that you have and understanding you have about a business plays a big role in how you deal with these tough times. On the one hand, with Netflix, we had a lot of conviction. We understood the drivers, we assessed all the reasons why growth would stall and what was a permanent reason, like maturation of penetration is the permanent reason why growth has stalled versus temporary reasons. But also, it’s one thing to have conviction in your research and the business, but on the other hand, there’s a lot of unknowable things in the world that happen, right? And so you have to have an open mind about that as well and be open to reassessing your position.

[00:21:11] Arif Karim: In this case, we held on, we even bought more stock on the way down. But certainly there’s other instances in the past where things didn’t play out as we would’ve liked. And in the process we, in our reassessment, during tough times, we had come to the conclusion that we had to sell because this was a more permanent thing that we hadn’t seen.

[00:21:28] Arif Karim: You know? So, you know, this case things turned out well, but that, that’s not always the case, of course.

[00:21:34] Clay Finck: I love how you just talked about how the market assesses the value with regards to what’s happening today. So when you look at the chart of Netflix’s global paid subscribers, it’s nothing short of a remarkable chart.

[00:21:45] Clay Finck: So the chart I’m looking at here, it goes back to 2014, and at that time we’re seeing 50 million paid subscribers. Pre COVID. We hit just shy of 200 million. And today we’re at over 300 million, so that’s a six x increase in the paid subscribers over a 10 year period. It’s just remarkable with regards to say the intrinsic value of the business is likely going in a similar trend alongside that, but the stock price is, is bouncing up and down along the way.

[00:22:14] Clay Finck: And in hindsight, 2022 was a time where the market overreacted with regards to what the value of Netflix was, which presented a, a good opportunity for you to add during that time. Let’s talk about some of the things they did over the past few years with regards to helping re-accelerate that growth.

[00:22:32] Clay Finck: So there was four quarters in 2022 where growth was essentially flat. But they did a few things that are to me are pretty interesting. So one thing they did was clamp down on password sharing, which is unfortunate for some users like myself. And another thing they did was release a lower priced plan that also delivers ads.

[00:22:52] Clay Finck: So that in itself is also pretty interesting to me and sort of resembles some of these other media companies. How about you just talk about some of these initiatives they’ve undertaken in the last few years and how that’s impacted their business?

[00:23:04] Arif Karim: Yeah, it’s really interesting and, and to your point, the catalyst was that slowdown in subscribers in 2022. Right?

[00:23:09] Arif Karim: And I’d mentioned that we had faith in management in the sense that it’s a management team that’s gone through challenging period before. And that culture of ingenuity and adaptation is a really strong set of characteristics that permeates the culture. And so one of the things we knew going in, and we’d been following Netflix for a long time, so.

[00:23:28] Arif Karim: I had the sense that something like 20 or 30% of the total viewers on Netflix are people such as yourself and myself, honestly, that were sharing a password with, you know, their parents or their sister, or their brother or their friend or whatever, right? And so we knew that that was historically something that Netflix kind of encouraged actually to drive virality of the service.

[00:23:47] Arif Karim: You know, once you start watching the content, at some point, if they were to turn the switch off, you’d be willing to pay for it because they’d already demonstrated the value to you, right? As being a habitual viewer of their content. In 2022, they started talking about restricting password sharing concurrently with coming out with a lower price.

[00:24:06] Arif Karim: Not only think it specified how low a price, so they just said an advertising driven subscription plan as well, which presumably would be lower price, potentially free, right? Because one of the things we knew was that Hulu, which had on the order of 40 to 50 million subscribers, most of their subscribers are on an subsidized plan.

[00:24:26] Arif Karim: You pay a cheaper plan per month, and they were generating something like $10 per subscriber per month. We knew there was about $10 of revenue that Hulu was able to generate per subscriber every month, which subsidizes the plan that they offer to their customers. And so we thought Netflix would be able to generate at least $10 as it rolled out the ad plan and figured its way through how to build that business over time.

[00:24:53] Arif Karim: What’s interesting is that Netflix’s engagement is on the order of two hours a day per subscriber, and that’s higher than anybody else. And so again, it gives you a sense for like, oh, if Hulu can generate 10 bucks, maybe Netflix can generate more ’cause their engagement is higher. Right? And then the question was what would they charge that service?

[00:25:11] Arif Karim: It could be, I thought it would be about like 2.99. I didn’t think it would be free. It could be free, but I think it would be free. They came out at 6.99 at the time, and he just, just took their price up to 7.99. Interestingly, it was around the time that one of the co-founders of Netflix, Reed Hastings, who had been CEO, stepped back and he had in the past adamantly not been a fan of bringing advertising to Netflix and under new leadership, and, and he blessed them and all, and, and he admitted that, you know, maybe he was too stubborn about the advertising piece.

[00:25:39] Arif Karim: But under the new co-CEOs, Greg Peters and Ted Sarandos, they decided to move forward with an ad plan. There were several things they had to develop here, and this is one of the things with, just for context, Netflix, when they talked about bringing their ad planner, justing password sharing, talked about a hundred million people in the world that were sharing the borrowing passwords.

[00:26:02] Arif Karim: And so there was a market there, an untapped market of people that are getting value from the service but aren’t paying for it. And the question is, how do you get them to pay for it? I mean, everyone assumes that people borrow passwords for economic reasons, but that’s not necessarily true. Right?

[00:26:15] Arif Karim: Sometimes it’s just convenience. Sometimes it’s like, you know, oh, hey, we’re family. So I mean, yeah, right? One person, the family pays a subscription, why not? You know, just all kinda sharing it. There’s like non economical reasons why people do this kind of stuff, right? And so the way you find out how this all plays out is by restricting password sharing, and then you’ll see how it plays out.

[00:26:36] Arif Karim: I think it was very smart for Netflix to come out with a cheaper plan to make it easy for people to switch over from borrowing a password to paying for their own service. They also rolled out another aspect of the service, I guess, where if you wanted to continue borrowing a password, well the person sharing that password could pay for you.

[00:26:52] Arif Karim: They could pay something for you. So if you’re a parent with a college student or if it like me, if it, if it was me subscribing, my parents were, you know, borrowing from me, I would just pay the extra bit into that, continue letting them borrow from me kind of thing. Right? So I think they came out with a relatively flexible way of like figuring out how to better monetize all those borrowers and they changed their marketing aspects around it.

[00:27:12] Arif Karim: Right? So obviously it’s worked out pretty well actually. And just on this, what’s, what’s really interesting to me is that there’s various ways that, just kind of taking a step back to, to the bigger picture, going back to like what I think is a great business. I think great business is one that creates value for its customers.

[00:27:27] Arif Karim: And then the second piece of it was, how is that business able to share in that value, right? So what can they collect to generate returns on their business? Different businesses have different strategies on how they attack that problem, right? In a way that ultimately you want your customers to love your product or service.

[00:27:44] Arif Karim: You want them to feel like they’re getting more than what they’re paying for. So in my mind, that’s the best way to generate loyalty amongst your customers is when they feel like they’re getting such a deal from you, right? Where I get so much value and I don’t mind paying you this much. And what Netflix has done is over time they’ve increased the value of their service, more content, more variety, et cetera, and then charge a little bit more along kind of a face that value along the way they’re bring their customers.

[00:28:09] Arif Karim: I think it’s a great way to model a business and build a business that had durability to it. I think the other piece of it is that it speaks to kind of that ingenuity that Netflix has. So one of the things they do, they, when they rolled out that advertising plan, I think it was across like 12 countries, they talked about kind of this fall run walk model that they talked about in building a new ads service.

[00:28:29] Arif Karim: Basically, because we ad service subsidize the user. But the ad service really is about the advertisers, right? They have to build out this whole infrastructure. Initially, they partnered with Microsoft, but they’ve been building out their own service prior to 2022. They also started rolling out gaming as a free add-on.

[00:28:47] Arif Karim: But again, another way to kind of take more of your time for entertainment services, come to Netflix and use their content, whether it’s for video gaming and over time, then be able to charge you more for it, right? As you see more value out of it. But all those things are, they call it crawl, walk, run. I call it experiment, learn scale, right?

[00:29:07] Arif Karim: That’s really what this doing. And so these are all great examples of how Netflix’s culture is able to increasingly scale the type of value that provides, which then ultimately accrues to shareholders and the value of the company.

[00:29:22] Clay Finck: I can’t help but think of a Munger’s rule of reciprocity with regards to Netflix.

[00:29:28] Clay Finck: I think it’s a pretty good case study. I mean, you know, on the one hand, they are building the habit of users watching Netflix, but on the other hand, the users realize, hey, this is worth way more than what they charge for it.

[00:29:40] Arif Karim: There’s one more point, if you don’t mind, on the topic of the password borrowers becoming subscribers.

[00:29:46] Arif Karim: I, that’s been super successful from what we can tell. So in 2022, they had roughly flat growth, right? They, they shrank a little bit in the first half and they kind of recaptured it in the second half, 23, we saw accelerating growth where I think they added 21 million subscribers or something like that.

[00:30:02] Arif Karim: But I know last year in 2024, they added a record number of subscribers. They added 41 million subscribers. So think about that. The market in 2022 is saying, this is dead, it’s not gonna grow anymore. And yet in 2024, just two years later, they’re able to pull the levers they do to grow 41 million, a record number of subscribers, which is incredible.

[00:30:22] Arif Karim: But he said that part of that, and we don’t know how much of it is the conversion of borrowers into paying viewers helped by advertising, right? Last year the number was 55% of new sign-on were subscribing to the advertising service, right, to the cheaper price plan. We think that it will be around the same similar sort of economics as kinda a standard plan of, you know, $18 a month kind of thing.

[00:30:47] Arif Karim: When all is said and done, and the company just talked about getting to that advertising scale this year is when they actually have the scale in the number of viewers watching that advertisers are interested in investing lots of money into with Netflix on the advertising front. Going forward, there’s an implication.

[00:31:05] Arif Karim: To the borrowers that are converted, right? Like we don’t know how many more borrowers are left to convert into subscribers. What’s really interesting is Q3 of last year, management said they’re no longer gonna share subscriber numbers on a quarterly basis, and that they want us as investors and Wall Street analysts to track their progress based on revenue growth, profitability growth, and free cash flow, which truly are the right output numbers to track.

[00:31:32] Arif Karim: But as far as input goes, now we won’t know how much of the revenue growth is subscribers versus ARPU, you know, which is average revenue per unit per month, which is a combination of people paying subscription fees and advertising, right? My hunch is that they will tell us, you know, certain milestones. I mean, when get to three 50 million or 4 million subscribers, they’ll put out a press release about that.

[00:31:53] Arif Karim: We don’t know when that’s gonna happen, but we’re not gonna have quarterly numbers. On the one hand, I think that’s kind of a good thing. Because at the end of the day, you want to get off this treadmill of just focusing on a number of subscribers because now you can actually start to monetize your customer base in different ways.

[00:32:08] Arif Karim: And that’s what we’re seeing. But on the other hand, kinda also from a skeptical perspective, it also makes me think, well, maybe they know something I don’t, about how much of their borrowers had flipped. And my own expectation is that there’s still room to grow subscriber numbers, something like the order of 20 million per year for a number of years, plus or minus.

[00:32:26] Arif Karim: But it’s kind of lumpy. I’ve noticed that in my history in the past, every quarter that there was the Olympics or the World Cup or, you know, this big event, there’d be this dip, you know, almost like clockwork, this dip in the number of subscribers. But again, because people are busy watching the World Cup, right, or whatever it is, right?

[00:32:40] Arif Karim: And any of the, the stock would like be down 10 or 15% or something like that, people would freak out about it. At the end of the day, the way I think about the business is the value they provide, how they increase that value to the customer. And how willing the customer is willing to pay for that value, right over time.

[00:32:56] Clay Finck: Another good point you you’ve made here on Netflix is just their willingness and ability to adapt to the environment they’re in and figure out new ways to provide more value to customers. So this ties into my next point here where previously you’ve mentioned that Netflix has a grand vision of addressing all of one’s TV needs.

[00:33:16] Clay Finck: So in 2024, we saw things like them playing a couple of NFL games on Christmas Day and featuring the Jake Paul, Mike Tyson boxing match, which reached 65 million concurrent streams. I’m curious to get your take on whether you see this vision playing out for them long term or, and if there are any other initiatives that sort of stand out to what this might look like going forward.

[00:33:39] Arif Karim: I think at the end of the day, Netflix does want to be kinda your baseline video entertainment and at some point gaming entertainment. But for now, the video entertainment baseline subscription that you have. And so in order to do that, you need to do a whole host of things. You had mentioned earlier that they spent $17 billion on content every year, right?

[00:33:57] Arif Karim: That’s a lot. But when you think about the scale that they’re attacking, right? You’re bringing content to the world, right? And so there’s 8 billion people in the world. They have varying tastes in what kind of content they wanna watch some like highbrow content, some like low, some like movies, some like series.

[00:34:13] Arif Karim: Some like in one language, there’s like another, they, they did a phenomenal job of getting content from around the world like nobody else has been, has done this yet. Something I’ve wanted to look up, and I don’t know if it’s publicly available or not, is what percentage of their total content is non-English, because it used to be that most of their content came from America, basically English content that’s distributed globally.

[00:34:35] Arif Karim: That’s kinda the typical Hollywood model that most other streaming services have. But Netflix was a pioneer in trying to develop a local language content for the local market, but then certain bits that become big hits through the discovery mechanism. Pitching that to all of us, as you know, on our first page when we turn Netflix on pitching us some international piece of content they think we might like.

[00:34:56] Arif Karim: So that brings leverage to a bit, to the point of like becoming kind of this ubiquitous baseline content provider for everybody in the world. That’s a huge challenge. It requires a lot of investment. I think if it does get there, that’s gonna be a huge piece of the durable value that Netflix provides as a company to people across the world.

[00:35:15] Arif Karim: Of course, part of this is sports content and live content, right? So that’s something that Netflix has been experimenting with historically. They’ve talked about how the live sports content licensing is very expensive. It didn’t make economic sense for them, and you can imagine that that to be a case when you’re charging 18 bucks a month, right?

[00:35:31] Arif Karim: And so they’ve chosen not to participate in sports in the past, but as they get bigger, the scale starts to change the economics for them and the scale buying power change economics for now. I’ll give you an example. So Formula One, in America, we didn’t really watch a whole lot of Formula One, but it’s big in Europe and Asia, right?

[00:35:49] Arif Karim: Kinda one of the first forays Netflix did into sports was to try to create entertainment around a live sport thing. So with Formula One, I think it was maybe six years ago now, they launched Drive to Survive, which is a series that follows the formula one season, but it’s kind of a story behind the teams, the rivalry between teams.

[00:36:09] Arif Karim: It’s all like super interesting and fun to watch, but then it triggers your interest in Formula One, two, the racing, right? And so Formula One is a separate company that works with Netflix to develop this show. And Formula One has definitely gotten a lot more interest. I mean, now in the US we have the Miami Grand Prix, we’ve got the Las Vegas Grand Prix.

[00:36:26] Arif Karim: The number of people watching Formula One in the US has increased, and we of course, are the largest advertising market in the world. Traditionally, live sports, the big source of revenue has come from advertising, right? And so we’ve seen this complementarity or symbiotic relationship between live sports publishers, I guess you could say, whether it’s Formula One or NFL or NHL and Netflix, which brings a story.

[00:36:49] Arif Karim: But at some point you could see Netflix then getting to the scale where they can cut a deal with these guys to license the programs that live sports programming. For initially it’ll be places where it’s not shown. So NFL is huge in America, but it’s not very big in Germany. I’ll say. I don’t know, I’m just guessing.

[00:37:05] Arif Karim: Right? And so you could see a thing where maybe Netflix can’t afford or doesn’t find the economically compelling to license NFL for America, but maybe they license it for live broadcast in other parts of the world and helps NFL grow its franchise in the rest of the world, just like it did with Formula One.

[00:37:19] Arif Karim: So I think we’re gonna see partnerships like that. And to your point, like secondary sports, you know, sort of second tier sports, like the fight with Mike Tyson and Jake Paul, it was a special event or you know, the niche sort of NFL on Christmas, which apparently was a big success for them, right? You’re starting to see them experiment with some of this stuff.

[00:37:33] Arif Karim: But I could see them bringing, I mean, they’ve already licensed a deal with wwe, bringing that to the world basically on a live basis. So, you know, could they do some UFC perhaps, but I could also see them do something with NBA or NFL or Premier League Soccer. To me, premier League Soccer is the one that’s the most interesting when they license Premier League soccer games, like globally distributed.

[00:37:54] Arif Karim: I think then you’ll know they’ve like basically do, this is their capstone domination moment, right? Of like, of the question that you’re asking.

[00:38:02] Clay Finck: So I wanted to transition to Ferrari here. We’ve covered a number of luxury companies here on the show. Two of which that are most well known to our listeners would be LVMH and Hermes.

[00:38:13] Clay Finck: And the luxury sector overall, I think has received a lot of attention for good reasons. One of which is that the number of people who can afford luxury globally is projected to continue to increase at a good clip going forward. And interestingly, you’ve been invested in Ferrari for a number of years.

[00:38:30] Clay Finck: How about we just kick it off other than maybe being more interested than cars, than handbags, for example. What made you select Ferrari out of the luxury names?

[00:38:40] Arif Karim: Yeah, it’s a good name, man. You kind of hit it on the head. I’ve always been a far fan since my teenage years, but in general I always have a perception that this, because I’m a fan of something, doesn’t send me as a good investment.

[00:38:50] Arif Karim: Right? And I remember when Ferrari used to be part of Fiat, which has a whole bunch of, you know, kind of normal car brands in Europe. And so it was kind of this rough diamond inside this car company. And fiat got no credit in its valuation for owning Ferrari. There was a little spinoff that happened in 2015, 2016, and I remember hearing about it and you know, Damodaran, the professor from NYU did a little analysis of it, and I think his conclusion was like it was overvalued and, you know, so I sort of peripherally had heard that, and I, yeah, I respect him.

[00:39:20] Arif Karim: I think he, he’s a good valuation guy, but at some point I saw, I think it was when he is 16, I saw a Morningstar research report on Ferrari. And so just like curiosity, I was flipping through it and I saw this chart and it’s really interesting, like how, you know, serendipity kind of plays a role in, in certain things, but I saw this chart and it just like really struck out with me.

[00:39:39] Arif Karim: The chart was revenue for in 2009 during the financial crisis revenue growth rate in that year for Ferrari compared to other luxury car companies and normal car companies. And we had a separate chart with Ferrari’s revenue growth versus other luxury brand companies. And what I remember was that in 2009, Ferrari’s revenue was down 7% and units were down like 4%.

[00:40:09] Arif Karim: Here is a purely discretionary product. You don’t need a Ferrari, right? I mean, maybe some of us do, but, but very few of us need a Ferrari. And the customer base is the customer base. That was like pounded in 2009, right? Like talk about like your wealth, your confidence, like you saw your wealth fall anywhere from 30% to 70%, you know, depending on who you were and what you owned, right?

[00:40:31] Arif Karim: Which is a huge impact on your psyche. Potentially your ability to spend or desire to spend. And that just hooked me. You know, I was like, okay, I, I gotta understand what’s going on here. This is totally surprising and not what I would expect. I would expect to see 30% decline in our sales. Right? And so then I started looking at the company and what I realized was that it’s a phenomenal business.

[00:40:50] Arif Karim: And this goes to your point of, of luxury in general is a phenomenal business. So with Ferrari in particular, the story was really interesting to me. They were building 7,000 cars a year at the time, roughly, right? 7,000 cars, like that’s peanuts. There’s not that many cars to sell. Which kind of explains why they didn’t have to cut back their production very much of their shipments, their clients, because there’s way more than 7,000 people that can afford to buy far, even in recessions.

[00:41:16] Arif Karim: I mean, people make money in recessions too. Like certain, it just changes who makes money. One of the clues to me about this was, was this chart, which then led me to look at Sergio Marchionne, who was the CEO of Ferrari, whose decision it was to spin this out. And I call it a rough dive in because when you looked at the numbers, it was like, you know, pretty compelling.

[00:41:33] Arif Karim: But he was talking about giving clues to the margins, improving more towards hermes’s levels. I noticed that they had grown units like two, three, 4% a year on average in the past. Pricing grew three to 4%. As I took all this in and understood what they were trying to do, and this idea of exclusivity where you had this supply demand mismatch, it became very clear to me.

[00:41:59] Arif Karim: So as you analyze the company, like one of the things that we understood was that, okay, there were at the time something like 5 million high net worth customers. In my mind, that’s like, you know, people that worth 5 million or more. So they had lots of discretionary dollars spent on a Ferrari. If you look at the number of units they were selling on that 5 million, it was less than one 10th of 1% penetration.

[00:42:20] Arif Karim: So clearly there was room to grow there, and one of the things that Ferrari had talked about was they only had two-door sports cars in the products, right? All their cars are two-door sports cars. Clearly there was something to do there where you can make, make a four door car that went fast and was fun to drive.

[00:42:36] Arif Karim: And we saw this president with Porsche back in the early two thousands when they released a Cayenne. So they used to be a two door sports car company. The nine 11 was their crown jewel, right? But they weren’t making much money. They were like on the verge of like collapsing with the nine 11 alone. They came out with a boxer, which a two-door sports car, but really their fortunes took off when they came out with an SUV, the cayenne with four doors.

[00:42:57] Arif Karim: And at the point that I was living in Ferrari, I mean the SUV, that Porsche were selling more units, like way more units than the nine 11 was, right? Which is the genesis. But yet people bought the Cayenne for the sportiness of it, the Porsche brand, whatever it is, right? So it was clear that Ferrari had ways to basically expand the value of monetizing its brands by changing the form factor and bringing a Ferrari experience to it.

[00:43:24] Arif Karim: Everybody knows the Ferrari brand, and so it’s an aspirational brand. So that piece of it too, I was a little surprised when I read that research report. They’d only grown their prices on the order of three, 4% a year, which is inflation, right? So this is a veblen good. The idea of it is just that you take the price up, you increase the desirability of it or the demand for it, right?

[00:43:44] Arif Karim: And so this is particularly true of luxury goods as opposed to commodity goods with luxury goods because they’re differentiated and people want them. Ferrari had the ability, I thought, to grow their pricing faster than that 3%, almost incumbent on them to grow their pricing five to 10% a year on average, because the wealth of their customers was growing at that rate, right?

[00:44:03] Arif Karim: If you think about their customers, they’re usually tied to a business whose equity value’s growing, or the equity markets that grow seven to 10% a year on average, right? So you could see how they’re limiting supply, but in general, the number of people who could afford a Ferrari is growing. If you have limited supply and the number of people that can buy your product is growing and they’re aspiring to your product, but you end up being on a wait list that’s extending and extending and extending, that’s a form of a frustration.

[00:44:31] Arif Karim: That’s not aspiration, right? The ideal way to manage a luxury brand is to be the aspirational thing. I can get to it once I get to a goal of some kind or a certain level of, well, whatever the metric is, right? For aspirational with Ferrari, I felt like they were both underpricing their products in the way they were growing pricing, but secondarily or frustrating customers too, which is the wrong thing to do.

[00:44:54] Arif Karim: The right thing to do is to keep your customers wanting the product in an aspirational way, and the way you do that, I thought, is to increase your pricing substantially, right? Because now it’s no longer I can afford to have this, but I can’t have it. It’s like I can’t afford to have it, but I’m gonna get there someday.

[00:45:11] Arif Karim: Right? And the byproduct of that is that they had to grow their pricing five to 10% a year. Of course that makes their customers, they can afford it feel even better about themselves. Right? It’s a status product, right. It drives the value of the product up and kind of a byproduct is that it really helps shareholders a lot because your profit margins go up.

[00:45:30] Arif Karim: It was actually the first time that I had this idea of, you know, kind of the ideal company as being this win win win model. And it was the first company as an investor, as I thought through it, I understood the business that the idea sort of solidified for me, which is that there is an ecosystem around every company, right?

[00:45:47] Arif Karim: And the best companies are those where all the stakeholders that interact with the company all feel like winners. Right? And how do you get that? When we think about companies and the way they deal with suppliers, for example, you know, like a Walmart or somebody, you know, they’re just like pounding on their suppliers to get the prices down, right?

[00:46:06] Arif Karim: It’s not fun to be a supplier at Walmart, but the best ones are where like, you know, I have several customers. One customer suits me so well, right? Like they create so much value with their product. They make so much profit, profit that they have enough to share and encourage me to work more closely with them, encourage me to give them the best product and supply.

[00:46:27] Arif Karim: The other company that reminds me of is the Whole Foods. In the past when they were building the company, they would pay the highest to the farmers so long as they could get the best of their supply for their customers. And so it’s this win-win, win kind of system where, and that means that when, when you come upon tough times, all your stakeholders are so intricately tied to you and have such goodwill towards you.

[00:46:49] Arif Karim: If they’re willing to pull much, much harder for you to get you through that tough period and to be winning. It also kind of disengages in a very natural way, your competitors, right? Because your customers are really happy with you, there’s not really a reason for them to go look at your competitors or even get, pay much attention to your competitors so long as you’re providing what they think is the best solution for them, the best value, however it is that you create this winning situation for your customers.

[00:47:13] Arif Karim: One thing just to end with during the covid shutdown period is like when you look at how and, and the reopening, how Ferrari treated their employees, it was pretty amazing actually what they did to take care of their employees, their health, their family’s health. Actually, it’s a phenomenal business and the culture there I think really espouses this win-win win model, which is exactly the kind of company that I think you are more likely to win with as a, as a shareholder, when everybody wins the shareholder, even two.

[00:47:39] Clay Finck: Yeah, it’s pretty remarkable that a company that sells 14,000 cars a year is about as well known as Ford, which sells four and a half million cars per year. And one of the things you’ve mentioned to me with regards to Ferrari is how customers of Ferrari are almost buying into being a part of this community.

[00:48:00] Clay Finck: I had read their annual report from 2024 and I was quite surprised to see them share that 81% of their cars were sold to existing clients and 48% of those clients are current owners who own more than one Ferrari. So you explained to me how many of these Ferrari owners are collectors of of Ferraris, and I think this ties in well to the, some of the scuttlebutt research you did of attending one of their events.

[00:48:29] Clay Finck: So how about you talk a little bit about that?

[00:48:32] Arif Karim: It was kind of an eyeopening moment for me ’cause you know, in my first year that we owned Ferrari, I had done this financial analysis and we had this thesis. We went to this customer event that was tied into an analyst event that Ferrari hosted its first investor day meeting in 2018.

[00:48:46] Arif Karim: And they had this customer event there where their best customers were invited to come see the launch. The premier of the first of their, what they call the E Kona line of limited cars. So they used to just have these hyper cars like the LA Ferrari, the Enzo, the F8, F50, F40, that would come once every decade, roughly super exclusive and only reserved for their best customers, right?

[00:49:08] Arif Karim: So passionate Ferrari collectors also want to be the best customers because they want to be invited to buy these highly exclusive, very limited production vehicles from Ferrari. So Ferrari launched this new line, kind of in the vein of the hypercar called E Kona Line. You know, these cars cost millions of dollars.

[00:49:26] Arif Karim: They invited some of their investors and Wall Street analysts to come to this customer event in 2018. And so they, you know, they had the premier launch would kind of experience what these customers experienced when they had this premiere. It’s a big show. They brought on the SP one and the SP two, then they had a reception where the cars were sitting on the floor.

[00:49:44] Arif Karim: Everyone can go look at ’em, take photos of them, go sit in the car. But in the meantime, you know, you’re online, you’re waiting for your turn and you talk to customers, right? And so I talked to a number of customers, but this one customer especially like really stuck in my head as kind of the kinda the icon of customer, right?

[00:49:59] Arif Karim: Like we’re just having this casual conversations. We’re waiting online. And he was probably, I’m five five, he is like six three, he was probably in his sixties. We were watching someone in front of us get into the car, you have to kind of contort yourself to get out of the car, get in the car. And so I was like, oh, so what do you think of the car?

[00:50:14] Arif Karim: He is like, oh yeah, I love this, this, this, this is beautiful. I was like, so do you think you might wanna order one of these? And he goes, I’ve already signed on the dotted line. I’m getting one of these. And what was really intriguing to me was that I’m pretty sure he didn’t know exactly how much it was gonna cost.

[00:50:29] Arif Karim: None of us did, right? And so we knew it was gonna be on the order, but like a million dollars. But the point of it was that it didn’t matter what the car cost to him, it was that he had to have it. And he also knew that once it landed in his driver, it was gonna be worth more. So it’s a no-brainer. Right?

[00:50:46] Arif Karim: And thirdly, if you’re invited to this kind of a event, the invitation is associated with an invitation to buy the car as well. If you don’t sign on the dotted line, maybe you don’t get invited again next time, right? Somebody else does. Because that’s the whole point, right? It’s a show and tell. And so it really brought home to me this idea of like just how special these cars were.

[00:51:06] Arif Karim: That conversation, he says to me, oh, tomorrow I’m going to Barcelona for this track that Ferrari had hired for these customers that want to go to Barcelona and go race around the track in a private event, right? He actually had a Ferrari, I think it was FXX, which is like a track only car that Ferrari had like organized to bring to the track for him to drive on the track.

[00:51:29] Arif Karim: I mean, this is all an experiential thing. And of course you have lunch, you meet up dinner, and in the process you’re meeting other peers of yours from around the world who are passionate cars, but also successful, wealthy. And it’s like at the end of the day, if you make these connections and you get one deal done during the event you’ve paid for your car, right, kind of thing.

[00:51:49] Arif Karim: So it’s way to think about it. And it really broadened my view of kind of what it means to be a Ferrari owner and a member of this. Basically, it’s like a global scale country club, right? The most elite, wealthy people kind of thing. And so I think that club aspect to that network aspect to it is also really important when it comes to driving the value of Ferrari.

[00:52:08] Arif Karim: It’s not just the piece of art in motion that you’re collecting, it’s also the networking that you’re doing with with peers, you know, and kind of your socioeconomic group, you know, from around the world.

[00:52:20] Clay Finck: One of the aspects of a business I think a lot about with many names I look at, is simply just the durability.

[00:52:28] Clay Finck: A lot of companies connect you well during the good times, but what happens when things don’t go quite well as planned or things just simply aren’t going as well? So in 2023, many people have been discussing global slowdown in luxury, particularly in China, and that was sort of an opportunity for some of the best of the best luxury companies to showcase that they’re different from all the others.

[00:52:50] Clay Finck: How about you talk a little bit about that slowdown and maybe how Ferrari has fared through that?

[00:52:55] Arif Karim: So the short answer is Ferrari is then great, I’m fine. That’s slow down in part because of their business model, right? So they take orders for their car as well in advance at shipment, there’s a tiering system within Ferrari, right?

[00:53:08] Arif Karim: Like the entry level Ferrari that now cost something like three $50,000, you know, have the most units you know, to be sold. Like four or five models, they’re kind of in that entry level segment, which is sort of in the 300, three 50,000 range. There you’re gonna have kind the most variability from an economic perspective, but as you go up the hierarchy to the more exclusive models, you have the least variability because exactly ’cause that, that customer story I, I relayed right where that customer is a collector, you have to purchase several Ferrari’s to be invited to buy this very exclusive car. It brings a lot of status to you as well. There’s a customer in Florida who sued Ferrari because he was dropped from their list to buy a LA Ferrari, which is like a one and a half million dollar car, right?

[00:53:49] Arif Karim: And so he was like, my reputation is tarnished. So because Ferrari won’t sell me this one and a half million dollar car, I deserve this. So that kind of dynamic, you start to understand kind of the, the way Ferrari’s business model can be impervious to short-term economic fluctuations. And so the supply demand imbalance increases as you go up the hierarchy of cars.

[00:54:13] Arif Karim: And so to the extent that there’s a slowdown, you would expect to see that at the very bottom, the entry level cars interesting for Ferrari going into 2023, they had already sold out their 2023 production and well into 2024. And on their earnings calls, analyst would ask them what the cancellation rates were you know, were they increasing questions like that to kind of understand the resilience of Ferrari’s order books, right? In that period, because we were observing other luxury companies having trouble. You know, also, by the way, there’s nothing unusual in Ferrari’s order books. In fact, you know, by the end of 23 to 24, it was starting to extend 2026, their order books, they were sold out through 2025 and now orders were coming in for 2026.

[00:54:54] Arif Karim: So it’s been very resilient in part because of the way their model works. You have to understand, like you could have 10 customers cancel orders for one of the higher ranking, more elite cards, and there’s probably 20, 30, 50 more waiting to their take their place, and that’s kind of where they manage their business, right?

[00:55:12] Arif Karim: What’s really interesting too, is like if you look at pricing, I did this analysis, it was at the end of 2023 where I went back and looked five years prior. From 2018 to 2023, the average selling price of a Ferrari went up by a hundred thousand Euro from roughly 300,000 to about 400,000. They had raised their average selling price by 30%.

[00:55:32] Arif Karim: What’s interesting is back in 2018 when I visited the company and I had this thesis in mind about them not being aggressive enough and raising pricing, and it was a disservice to their customer. I had this conversation with the marketing head of marketing there, Enrico Galliera, and he was like, well, you know, you can’t just raise price on customers.

[00:55:49] Arif Karim: You have to give them something for it. And I was like, well, at the end of the day, you’re doing a disservice by not pricing high enough. Because it kind of rewards them, right, for their status, which is why they’re buying a Ferrari, many of them. But at the same time, it also increased the frustration amongst potential customers who can afford one but can’t have one.

[00:56:05] Arif Karim: You don’t want that situation either. I don’t know if it was my and, and then I’ve written about a blog about it too, that that issue that the pricing, you know, issue before, but as it turns out, the last five years you can see that they’ve been following kind of that playbook where prices have risen dramatically as they’ve rolled out new models and slotted in new models at higher ASPs as well.

[00:56:26] Arif Karim: Whether you look at the SUV that went on sale, I, it was the end of 2023 that was sold out to 2025, and now it’s 2026, that there were estimates all over the place. You know, I thought it’d be somewhere around $500,000 and that’s kind of where they came out. But that was a new entry point for what they call range model, which is non-exclusive, right?

[00:56:43] Arif Karim: Because this is where they higher volume units, similar to the SF 90, that type of car hadn’t really existed before and they came in at, you know, five 50, I think roughly. So you can see that in pushing pricing up faster in the last five years, which I think has been the right strategy. Now you don’t know where the threshold is, but what you would know, they’re pushing on the threshold with customers that accept as fair pricing for them.

[00:57:08] Arif Karim: If orders start to come in, like that order backlog came in. I mean, at this point we’re looking at 24 month type backlogs, right? So it shows you just how durable their positioning is in terms of demand. They’re now, by the way, 40% EBITDA margins, which is pretty incredible up from like roughly 25 ish, you know, when they went public.

[00:57:31] Clay Finck: Let’s chat electric vehicles with Ferrari as well. So it was 2025, they launched their very first electric vehicle, which to my knowledge, I think could pose a risk to the driver experience, given that EVs don’t have high revving engines and aggressive exhaust and whatnot. Do you foresee their loyal customers being interested in purchasing EVs going forward?

[00:57:56] Arif Karim: That’s a good question. I, I think nobody really knows, and maybe Ferrari might have some inkling on this, so there’s several ways to attack that question, I guess, right. One is, I think it’s well understood that younger cohorts of people have different preferences than older cohorts of people. I think the number is, the average age of Ferrari owner is 55.

[00:58:17] Arif Karim: I think it’s been coming down and the reason why it’s been coming down is they’ve released hybrid models. They released the SF 90, roughly four or five years ago, and then the 296 GTS and GTB couple years ago. Those are both hybrid models and there was a lot of nervousness about how those would be received in the market, but they did just fine.

[00:58:37] Arif Karim: Both sold out their productions, both proved that Ferrari was able to basically improve efficiency while enhancing performance with that hybrid system. Right? So that’s the key sell with Ferrari is that party experience was performance is the performance characteristics of these cars is just incredible.

[00:58:57] Arif Karim: In fact, what’s really interesting is that the last hypercar, the LA Ferrari was actually a hybrid as well. No one talks about it, but it was the question of whether an EV that they’re gonna launch later this year in 2025. How successful that might be, I think is, is a bit of a question mark. But Ferrari has a very close relationship with their customers and so they got, and you know, pulled them and figure out, you know, kinda what their customers might want.

[00:59:20] Arif Karim: Having said that, Ferrari’s made it very clear that at the end of the day they’re making ice cars. They make hybrid cars and we make EV cars and they’re gonna let the customers decide kind of where they fall in their, just as messai. There’s a newish company that kind of launched the EV supercar model called reoc, which is now partially owned by Porsche, but I mean, they’ve had like amazing super cars come out.

[00:59:42] Arif Karim: These cars like zero to 60 in sub two seconds, they’re just like crazy, incredible cars. And then Porsche also came out with Theon, which is a EV four-door EV that was launched five years ago roughly, and initially did really, really well actually. And they were selling something on the order of 40,000 units a year.

[01:00:00] Arif Karim: And a price point of, I think ASPs, my guess would be roughly 120, 140. More recently, there’s been some issues with demand around that, which has some stuff to deal with. Part of the issue that these pons had very low range. They were like in the 200 mile range, which is on the low end of practical, so that might be part of the issue there.

[01:00:20] Arif Karim: They’ve improved that range with the latest model icons. But we’ll see what Ferrari does. I mean, at the end of the day, the value add that Ferrari brings to their customers is an experience. The sound is a part of that, and so that you have to decide as a customer how important that part of the experience is to you.

[01:00:35] Arif Karim: And the third is just the brand and the status that it brings to you, right? So there’s places that have mandates by 2035, you know, they only electric cars will be sold. This was in Europe, California as well. We’ll see if that holds. I think that’s part of the motivation for Ferrari to develop pure EV cars as well, is to hedge for that situation.

[01:00:53] Arif Karim: But having said that, EVs are not like this critical thing for Ferrari because they will decide based on customer feedback what the balance will be between, you know, the different types of fuels that are used.

[01:01:04] Clay Finck: I wanted to be sure to touch on valuation as well. We can start with Ferrari here. One of the interesting things about Ferrari is when you look back over the past decade, you’re seeing around 10 to 12% revenue growth on average.

[01:01:18] Clay Finck: And then you’re seeing some of course operating leverage and as they scale up, as they pull the lever on pricing. But what’s also interesting is that the valuation multiple continues to expand over time. So that brings a question of what is a fair valuation to pay for this company? I think there’s a pretty strong case that it should be trading at a premium to your average company out there on the market due to just the durability of the brand, its ability to continue to grow and just the inherent pricing power and their products.

[01:01:47] Clay Finck: I’m curious just to learn more how you think about the valuation of Ferrari.

[01:01:52] Arif Karim: I think Ferrari’s valuation the way, same way I do all of the companies that, that I’ve owned. And that is, you know, just based on the future value of cash flows that it can bring. And that forecasting is always a little tricky, right?

[01:02:07] Arif Karim: Because the future’s unknown and uncertain. But to your point, we’ve got a very strong brand, which has given them the luxury of driving their prices up as well as the number of units up. If you look at that 10, 12% growth, roughly, I’d say it’s roughly half comes from unit growth and half comes from pricing Growth valuation is always a function of what expectations are embedded in the future of a company.

[01:02:31] Arif Karim: And so I think it’s reasonable to think that Ferrari can grow its units at a low single digit percentage number, which is roughly in line with the rate of growth of their customer base. Right? And then with pricing, similarly, you talked about on average their customer’s wealth growing in the five to 10% range.

[01:02:51] Arif Karim: I think pricing can grow at that range, so the point of that being that to think of like a 10 percent-ish plus or minus, a little bit growth rate almost indefinitely at the stage that Ferrari is at with some 14,000 cars a year, right? It’s like not very much. It’s a reasonable way to kind of model how this grows.

[01:03:10] Arif Karim: I think the part that’s been super surprising to most people, and not super surprising to me is the pace at which their profitability has increased. And so they went from roughly 25, 20 6% EBITDA margins in 2016, roughly 40 today. And the question is how, how much higher can it go? Can it get to 45, can it go to 50?

[01:03:32] Arif Karim: Can it go to 60? What’s the limit? And I think that’s where there’s a big question mark on how premium its valuation should be. And the market, I think, wrestles with that ’cause at the end of the day, it’s a purely discretionary product. The company basically decides what their margins gonna be and then prices their car on that way.

[01:03:50] Arif Karim: Right? And so far we’ve seen no pushback. So for as long as the product and the brand are relevant and desirable, I think it wouldn’t be surprising to me if they could get to, let’s say 50% EBITDA margin that kind of hold there. And I think the valuation we’re seeing incorporates some expectation of kind of 10% dish growth indefinitely.

[01:04:12] Arif Karim: And by that I mean like, call it 10% indefinitely and margin expansion towards somewhere in the 45 to 50% range is my guess. Right? And that context of valuation makes a lot of sense. So valuations in theory are set by this discounted cash flow model, right? It’s basically thinking about the value of future earnings that the company creates and then you discount it back to today.

[01:04:34] Arif Karim: Because the theory is that future earnings are worth less than earnings today, right? A hundred dollars today is worth more than a hundred dollars in five years. And so you need to apply a discount. And typically the way we think about what the discount should be is the average rate that the stock market has returned, which is roughly nine 10%, right.

[01:04:52] Arif Karim: And so if you discount back future earnings, the farther out you go, the more that discount hits. It’s an exponential component. And so effectively when you look at market valuations, you’re talking about a 30, 35 year type of time horizon on free cash flows contributing to the majority of the valuation that we see today.

[01:05:09] Arif Karim: That’s the theory of it. How often that actually works in practice is question mark, right? It’s one way to look at it and, and it makes a lot of sense in a lot of ways. So having said that, I think the market thinks that Ferrari can grow 10% a year, roughly for the next 20 years, let’s say, and it’s comfortable with that, and that’s kinda what the valuation’s reflecting.

[01:05:28] Clay Finck: Yeah, it’s a tall task for managers at Ferrari to try to deliver that. So I was on a call with our mastermind community yesterday and one of our members highlighted that she had missed Netflix stock years back because it just wasn’t profitable and it looked like they were gonna be in this continuous cycle of needing to spend enormous amounts on content just to keep up with all the competition.

[01:05:54] Clay Finck: And with many great companies, they’re going to look optically expensive the vast majority of the time. And in the case of Netflix, if they’re significantly investing through their income statement, that’s going to reduce their gap earnings per share, and it’s going to raise their PE ratio that investors are looking at.

[01:06:13] Clay Finck: How do you think about making some of these adjustments in order to better make sense of a company’s valuation, especially that’s in their earlier growth stages like Netflix was.

[01:06:23] Arif Karim: That’s a really great question and a really great point you make. It’s something that’s taken me 20 years to figure out.

[01:06:30] Arif Karim: Honestly, it’s not an easy thing to do. A big part of it is stepping back and thinking about what valuation actually means. Right? So what valuation indicates is, and we touched on, you know, when we were just discussing, it’s what the market’s expectations are about, what the future cash flow the company will generate.

[01:06:48] Arif Karim: So as a point in time, let’s just take 10 years from now, right? If you were back in 10 years from say 2015, let’s say for Netflix, I think it’s a good example. Go back to 2015. At the time Netflix was roughly three years into its streaming business, right? Where it made that transition, 2012 being streaming first 2015 was three years into that business.

[01:07:09] Arif Karim: I don’t know if there were gap net loss, they probably were, but I can’t remember. But they definitely were free cashflow negative, and they were free cashflow negative because they were investing all this money in content. Right? And a big piece of what they were investing was in licenses from other media companies.

[01:07:24] Arif Karim: Right? And so to this person’s point that made a point that, you know, it was hard to tell how this would work if there were having to invest so much money into content. I think she was actually right in viewing it that way, but at that time, and this was roughly the time that I started looking at Netflix for their stream business and what implications it would have for the media industry, what Netflix was doing was investing in their business.

[01:07:46] Arif Karim: While there are companies that invest to their balance, to their income statement, I don’t think Netflix necessarily fit that precisely. They were investing a lot on their balance sheet to build up this content scale. And the reason is because they understood that at that time, they didn’t have much of a moat like they had grown to roughly, I think it was 50 million subscribers, maybe 40, 50 million subscribers, but that wasn’t enough for them to fend off.

[01:08:11] Arif Karim: Disney overnight saying, you know what? We’re gonna be a streaming company ’cause Disney’s brand was really well known. Their content catalog is really popular, and by licensing content from a bunch of legacy media companies to create the product that it would then sell to consumers with got service.

[01:08:27] Arif Karim: Netflix was vulnerable in the sense that if those media companies woke up and said, okay, you know what? We’re refused to license content to you. All of a sudden the product content is the product, the product that Netflix sells through its distribution service to consumers. It was a distribution company at the time.

[01:08:43] Arif Karim: If you lose product, you’ve got nothing to distribute, right? So there goes the value of the company. And so it definitely was at a little bit of a precarious situation at the time where it hadn’t quite built the moat that we see today. In order to do that, they rightfully had to start creating their own content, but they wouldn’t be dependent on just licensing content from media companies.

[01:09:03] Arif Karim: One interesting thing that happened was in 2009 or 10. Their first licensing deal for streaming was with Starz. Netflix had roughly 9 million DVD rental subscribers. They initially gave the streaming subscription for free, like as part of that DVD subscription, but they licensed content from Starz for $25 million.

[01:09:21] Arif Karim: I think it was a two year deal. Two years later, they had 21 million subscribers. And so when they went back to Starz to license the content, again, I don’t know exactly what Starz was asking, but they were asking something really unreasonable. Rumor had it in the media that they were asking for 10 times as much, they were asking for $250 million because Starz hadn’t realized how valuable that content would be to Netflix for its own streaming business to grow.

[01:09:45] Arif Karim: And so it was at that point, roughly 2011, that Netflix really understood that they need to build their own content and they started to do that. So if you have like a built out catalog that you license, it’s ready to go, right? So you just kind of deploy it like right away. So I’m paying, but I’m also deploying, I’m earning revenue off of it.

[01:10:03] Arif Karim: But if you’re creating content, you invest upfront. The content takes a couple years to make and then you deploy it, right? So you get this big imbalance between your revenue coming in for content and the amount you need to invest for the content that you’ll have in two years to support that revenue.

[01:10:18] Arif Karim: And so that’s something that Netflix went through. And now we’re at the point where like if you look at their amortization, which is kinda expensive of content, it’s half licensed, half their own. And the reason why I media companies didn’t cut off Netflix is because this was old content. They were licensed there to Netflix, they amortized it.

[01:10:36] Arif Karim: Depreciated already is essentially a hundred percent margin revenue, like hundreds of millions of dollars at a hundred percent margin. It’s really hard saying no to, right? Even though you’re feeding the devil that’s gonna destroy you potentially in, right? So if you look at the valuation looked expensive because it was investing.

[01:10:54] Arif Karim: The investing in the income statement was in building out that global network. So remember, they’re deploying servers, they’re partnering, they’re creating content for new markets that aren’t really revenue, generating that revenue. So this is one of the things where you have to build it first. Then you get attraction from consumers to your service.

[01:11:10] Arif Karim: Because the project is the content. So I have to make Korean content for most Koreans to subscribe to me. It’ll take me a few years to do that, to build enough content for Korea to make it attractive, or Japan or Germany or what, whatever it’s right. And so there’s a bit of a faith in the process. There’s a bit of a guessing game.

[01:11:28] Arif Karim: Another piece of it is, when I was looking 10 years out in my valuation work, you had to guess what will Netflix’s operating margins look like 10 years out? I think at the time was maybe 10%. Will it be 10% going forward? Will it be 20, 30, 40, 50? I don’t know. Right? One thing to do is look at media companies, you know, again, at the time, 2015 today, 2015.

[01:11:49] Arif Karim: If you look at media companies, their operating margins were in the high twenties, roughly, maybe low thirties for Disney. Perhaps they were probably the most profitable one at the time. And so you had some idea that, well, if this is a good business, which I think it could be, then operating margins could look like this.

[01:12:02] Arif Karim: Turns out that’s kind of how it played out over the last 10 years, where now Netflix is, management says that they printed 27% margins. I think last year they talk about growing their margins 2% a year, roughly for several years longer. And I sort of had them going to roughly 35% operating margins. Right? So it’s possible that because it’s a global scale business, that they might even exceed that ’cause that it’s the first time that the content business is a global scale business.

[01:12:28] Arif Karim: We’ve not seen that before. So regional scale. So you can look at like Google’s margins, you can look at meta’s margins, and of course they have different business models in terms of content. They don’t really pay for their content, right? And here you’re paying for it. So there’s like all sorts of nuances they go into.

[01:12:42] Arif Karim: But the short answer is, is it’s hard. But the key levers to content are what kind of growth do you expect over the next 10 years? What kind of margins do you expect? If you look at Netflix in 2015, and I’m just making this up like a 10% operating margin, if you assume it’s 10% forever, then it’s expensive at 35 times, right?

[01:13:00] Arif Karim: But if you are able to deduce that, maybe those margins will go up to 25% or 30%, well then you can kind of normalize that 30% today to get a better sense for what that normalized valuation might look like. Right? It’s scale, it’s acceptable. So it’s margins, it’s growth. And then to me, the third important thing that I used to not take as seriously, but I do very much, let’s say, is the probability the team, the people can execute on the plan.

[01:13:29] Arif Karim: That’s super hard. A lot of companies can’t do that. And so identifying the management teams that can drive the company and inspire the people to achieve the execution goals that they have to get those numbers, those were the three drivers of valuation generally.

[01:13:47] Clay Finck: Wonderful. Well, we didn’t have time to get to ServiceNow today, but as always, I appreciate you going so in depth here on Netflix and Ferrari.

[01:13:55] Clay Finck: So I’d like to give you just a final handoff here. For those in the audience who would like to get in touch with you or learn more, where can they go?

[01:14:03] Arif Karim: I’m a bit of a free agent right now and so they can find me on LinkedIn. I’m happy to connect and discuss. I’m working on my next venture, but one that I can’t talk about yet.

[01:14:12] Arif Karim: But yeah, would love to connect with anybody that’s interested.

[01:14:14] Clay Finck: Wonderful. Thanks a lot Arif. Really appreciate it and hope the listeners enjoy this conversation.

[01:14:20] Arif Karim: Thanks so much, Clay. Appreciate it.

[01:14:22] Clay Finck: Alright everybody. Thank you for tuning into today’s episode with Arif Karim. I wanted to take a minute to share some details on a new event that TIP will be hosting from September 24th through the 28th, 2025 in Big Sky, Montana.

[01:14:36] Clay Finck: The event is called The Investor’s Podcast Summit. We’ll be gathering around 25 listeners of the show to bring together like-minded people and enjoy great company with a beautiful mountain view. We’re looking to attract thoughtful listeners of the show who are passionate about value investing and are interested in building meaningful connections and relationships with like-minded people.

[01:14:57] Clay Finck: Many of our attendees will likely be entrepreneurs, private investors, or portfolio managers. I’m thrilled to be hosting this special event for our listeners and can’t wait to hopefully see you there. On our website, we have the pricing frequently asked questions and the link to apply to join us. So if this sounds interesting to you, you can check it out at theinvestorspodcast.com/summit.

[01:15:19] Clay Finck: That’s theinvestorspodcast.com/summit. We only have room for around 25 members of the audience, so be sure to apply soon if you’d like to join us with that, thank you for your time and attention today, and I hope you enjoy today’s conversation.

[01:15:34] Outro: Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only, before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.