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Capital 19 Catch-Up – May 28

My Way or the Huawei

The week was ridiculous. First, the US bans trade with Chinese company Huawei, so markets fell, but when they said they won’t implement the ban for 90 days, markets went up again. The US then said they might add the Chinese video surveillance company, Hikvision, to their list, and so the markets fell, before going back up again with the mention that the trade war could be over soon.

Overall the Dow dropped 0.7% for the week to post its fifth consecutive weekly decline, its longest streak since 2011. The S&P500 and Nasdaq fell for a third straight week.

This ban on trading with Huawei is interesting as it has nothing to do with Huawei selling their product in America as Huawei sells very few phones in the US. What it does, however, is stop American companies selling parts to Huawei so that Huawei doesn’t have a competitive product in other markets such as Europe, where their phones are popular.

It would seem that the US is trying to halt Chinese technological growth. It feels like a cold war. In response, China’s largest manufacturer of semiconductors, SMIC, announced it will withdraw its listing from the New York Stock Exchange and China gave their homegrown circuit makers and software developers a boost by reducing their local taxes.

Former White House Chief Strategist, Steve Bannon, said that driving Huawei out of the United States and Europe is “10 times more important” than a trade deal with China. He also said he would dedicate his time to shutting Chinese companies out of US capital markets.

The US has been the world’s largest country by GDP for some time. But China is fast catching up, and by some measures, has already assumed the top spot. All predictions are that it will outweigh the US soon. India might well also become larger if it maintains its current growth rate.

The U.S. is simply trying to defend their position against the inevitable.

So, how does this affect our investing? Short term opportunities will increase as the markets gyrate around each side’s movements. The longer term becomes much harder to predict and position for, so we aren’t going to try at this stage. We will let this story develop a bit more before we look for ways to profit from it.

 

Disney vs Netflix

Whilst we are on the topic of profits, let’s take a look at a long time favourite of ours, Disney, (DIS:NYSE) Disney owns the Marvel brand and its latest movie, Avengers Endgame, grossed $1.2bn in its opening weekend, shattering records for the biggest global launch for a film and underscoring Disney’s dominance of the movie business.  It is the first motion picture to make more than $1bn at its opening (the last record was another Disney film, Avengers Infinity War).

Disney has four more key releases coming later this year: Frozen 2, Star Wars: The Rise of Skywalker, The Lion King and Toy Story 4. Disney is a cash generating machine and with such a stable of brands and the associated merchandise the income should roll on for years to come.

But that isn’t the end of income for Disney, for they will be rolling out Disney+ shortly, the Disney streaming service. This is very bad news for Netflix (NFLX:Nasdaq) as a Disney streaming service will not only contain their entire back catalogue of movies and franchises but significantly also the Disney owned ESPN sports network

There has been a significant shift in viewing behaviour in the last decade. According to research by MoffettNathanson, in 2011, of the 100 most watched broadcasts, about half were sports. In 2018 sports accounted for more than 90% of the most watched broadcasts. Netflix does not offer any sports. Disney is going to spend around $6bn on sports for Disney+.

Netflix is also making some strange moves. It is paying close to $100m to keep the show Friends on its network for another year. That is close to $400,000 per episode for a show that last aired live 14 years ago.  They had to pay this to AT&T who own the rights.  It’s as if they don’t know what other content to offer. If Netflix is willing to pay $100m for Friends, what will they be forced to pay for The Office (rights owned by Comcast), the most viewed TV show on Netflix according to data company 7Park? Disney owns all its own content so doesn’t have these issues.

If you look at a head to head, Netflix vs Disney, it’s hard to see how Netflix comes out on top, and when you look at the PE ratios for the companies, NFLX at 126 and DIS at 15 then the best investment is clear. We rate Disney a BUY right now. In fact, you could even get smart and say long DIS and short NFLX to try and eliminate market and economic risk and generate alpha from the difference in relative performances.

 


 

 

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