TIP711: Netflix, Ferrari, & Managing Market Volatility w/ Arif Karim
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On today's episode, we welcome back Arif Karim. Arif has been featured on the show several times and has over 25 years of experience in the investment industry. On today's show, we discuss two companies that he knows as well as anybody, Netflix and Ferrari. Both stocks are incredibly interesting businesses as well as strong outperformers in the stock market. In this episode, we cover Netflix's moat and why Arif believes it's a great business,

How RF managed the share price volatility of Netflix in recent years. The growth initiatives that Netflix pursued in light of the slowdown in subscriber growth in 2022. Why Ferrari is a great business with win-win relationships similar to Costco. How Ferrari will fare as they transition to selling more electric vehicles. How RF thinks about Ferrari's and Netflix's valuation and much more. With that, I hope you enjoyed today's discussion with RF Karim.

Since 2014 and through more than 180 million downloads, we've studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now for your host, Playthink.

Welcome to the Investors Podcast. I'm your host, Clay Fink. And today, I'm thrilled to welcome back Arif Karim. Arif, thanks for taking the time today. Hey, thanks, Clay. Great to be back on your show and speaking with you again. Thanks for having me.

Yeah. Well, in preparation for this discussion, I was looking back at your previous appearances on the show, and I've really appreciated just the depth of the insights you provide. And I thought it'd be a great time to revisit some of the names we've discussed. So we've previously chatted about Netflix and Ferrari. So I wanted to touch on those again. So let's start here with Netflix. So this is a company you've been following for many years. And along the way, the stock has just been a massive outperformer. This company has just been a bit of a mystery to me. Just

due to one, the level of competition they have, and two, them needing to continuously spend more and more on content. So it's estimated that on their $39 billion revenue base, they're spending over $17 billion on content alone. So how about you outline what it is that makes Netflix such a great business in your view?

Yeah, sure, Clay. Netflix is an interesting one. I've actually followed it since the early 2000s, which was pretty close to their IPO. And at the time, they were a DVD buyout.

buy, mail, rental, subscription business. And that was a very innovative business model at the time. And of course, as you know, they've become a streaming video pioneer and leader globally. 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. So there's some sharing of what I call the value surplus between a company and a customer. And then you want a business that can protect its business with better advantages, that it builds against commoditization of the profit margins. And then it's only able to grow over a long period of time so that you have the ability to compound value.

investments in the business over many years. I think Netflix has all of those characteristics, right? It provides a valuable service to its customers. It's globally applicable.

It's scale and other characteristics that bring a moat aspect to the business that protects us from competition and protects profit margins, ultimately. And so we're starting to see aspects of that play out. 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 like to think of as empathetic voyeurism, where you get to live other lives through these experiences. And that's core to human nature, I think. From a Netflix-specific perspective, it really launched its streaming service just as the internet became ubiquitous globally. And in the past, traditional media companies

tended to be more regional because they were restricted in reaching their consumer audience via wires. With Netflix,

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 can look like for this business because of that scale and then and what the returns can look like. So we'll see how that plays out. It's in the process of playing out. And it's been exciting so far.

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?

Yeah, that's a great question. So obviously, scale is an important part of a month, but they had to build that scale, right? And there's, I think, other components that went into 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, like a set of what I call know-how capabilities that they built

that also gave them the ability to outcompete their competitors in the execution and building that scale.

So I mean, I think the scale is really important in this business because you can spend $100 million for a piece of content, 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 necessarily. But the per unit cost, that content changes dramatically, right? You go from $1 per customer to maybe $10 or $100 a customer, depending on 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. 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. But in getting there, 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 attractive it is to new subscribers. They come in, you have more dollars to invest in content. There's this flywheel that's involved in that. But there's these other capabilities that they have that are know-how capabilities that 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. 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 2016-ish timeframe, they started to build out their own content delivery network. 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 be watching the content to be as...

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. So in that, there's all this technical capability, whether it was compression, security of the contents, it couldn't be pirated at the time. I don't know if you remember, but back in the early 2000s and 2010s, pirating was a big issue of content, so you had to protect that content.

And then there's the latency issue, right? 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 because you're just as likely to get frustrated and move on kind of thing, right? 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 want to watch whatever the latest piece of content was that was hot. And then it would like overload their ISP network.

And so then Netflix would go to the ISP and be like, oh, hey, by the way, let us put a server in that last mile location where a customer is reaching out to download the video to start watching. And that'll take the bird off of you because we know that 10 p.m. in Rio de Janeiro, 80% of customers will watch these hundred things. What happened is the night before at 2 a.m. when no one's using your back end pipe,

We'll just download the 100 things that 80% of customers will watch tomorrow night. And that way, it reduces the burden for you, the ISP, from a cost and logistics and operations perspective. And the ISP would let them put their server there. But you have to have a certain scale to get there, right? And so that sort of thing, 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 Bantech, which had developed a good experience service in Disney Plus service so that they could have a similar type of experience. But anyway, there's a couple of examples of these core know-how detail things that

Netflix learned over 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. I'll just add that 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. 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 on to that moat and grow it. So that's all just keeps going.

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. And one of the other things that makes Netflix an interesting business to cover here on the show is sales.

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 $1,000 a share. 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 and

and the lessons you took away from that drawdown.

Yeah, that was quite an experience between November 2021 and through 2022. The stock had its biggest drawdown that I'd ever experienced as an investor. And I personally, as an investor, had experience in the portfolio stock that I was co-managing. It happened to be our biggest position to boot as well when I was at Ensemble. It was a difficult period for the stock 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. And so we had to go back and reassess all that work that we had done to see if we were missing something. And obviously the market had reassessed what the values of Netflix stock were because in that period, their subscription growth stalled. 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. 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 would be at least a decade 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 Netflix's model is they invest in content

And then they leverage that over their subscribers, right? 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, and your profit margins are also going to go up over time as a result of that. But if you stop growing, then all of a sudden, A, the market reassesses 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 reassesses your growth rate to near zero or 5%. That's a huge change in valuation based on the cash you'll be generating in

10 years, right? 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 cashflow 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. So you have this duality of reassessment. One was the growth got reassessed down, and the ultimate profit margin, the market expected, got reassessed downwards. So you had that double whammy. So at that point, you have to reassess how do your investments

In this case, how do our forecasts agree or disagree with what the market is now saying, which the majority is saying the outlook's going to be? And so you have to ask the question, ultimately it came down to that stall of the stalling and subscriber growth. So if you 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, all these streaming choices. You had Disney+, you had Hulu, HBO Max, Apple, Amazon are on there too. But what was interesting is in 2020, Netflix had its highest ever subscriber growth, right? As you recall, we were all stuck at home. A lot of people were bored. A lot of people had a lot of time on their hands.

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 bullwhip effect where they pulled in subscribers, maybe pulled forward some of the demand that they would have seen. That was one aspect of it. And that was playing out through lots of different industries, lots of different companies. But the other was that there was this narrative of competition. And that was one that we looked at 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 and what makes news was, oh, there's all this competition, right? 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? If you are a Marvel fan...

you're going to go to Disney. You're not going to find it on Netflix. If you're a fan for Squid Games, you're going to go to Netflix for that. You can't go to Disney for that. There's a lot of what I call commodity content that you can go to anybody with. And that's really just the time filler. You might be doing something else. You want to get in the background. Traditionally, 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. 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...

the distribution of subscribers on the service. The US had something like 70 million subscribers already in 2016. And so we viewed that as kind of mature markets. We weren't expecting a lot of growth from the US market. But we did expect a lot of growth 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. So you can't expect high penetration is my point in the US. But when you look to other places like EMEA, Asia-Pac, Latin America, it was still under-penetrated, massively under-penetrated. It was very small. So there's a lot of runway to go. And that was our thesis.

And for those not familiar, what's a Mia?

It's Europe, Middle East, Africa, but it's primarily the EU, so Western Europe. But fast forward to 2021, 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. And what we saw happen in 2022 is 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 how they reached maturity, right? Like we have 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, right?

And the key question really that you have to grapple with is, what does mature mean? Is 70% penetration of households 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. To us, the obvious answer was not competition. It was

the Ukraine and Russian invasion of Ukraine, right? When you have a big power invading a country in your continent, right in your backyard, are you going to be looking for something to subscribe to for entertainment? Are you going to be glued to the news 24/7? 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 things would get better, Russia would, and Ukraine would reach a ceasefire,

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 their old habits. And that's certainly what ended up happening as the year went forward.

But having said that, we also had confidence in the management team. We knew that there are levers that they had that they could pull over time. 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. 95% of economists thought there was a recession coming in 2022, right? Because interest rates were going up, inflation was high. That

That was the other thing in Latin America, there's a stall on growth because inflation was much higher than it was here. Netflix was raising prices like 15, 20% to keep up with inflation in Latin America, right? 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.

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, again, what growth is going to be like in the future and what ultimately profit margins look like, which would change how the stock is valued. And at the end of the day, that's what you have to do, right? For me personally, as I think about it, there's less than to learn 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. 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 driver's

We assessed all the reasons why growth would have stalled and what was a permanent reason, like maturation of penetration rates would be a permanent reason why growth would stall 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. 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 have 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. So in this case, things turned out well, but that's not always the case, of course.

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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. 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

over 300 million. So that's a 6X 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 bouncing up and down along the way. And in hindsight, 2022 was a time where the market overreacted with regards to what the value of Netflix was, which presented 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. 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. 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 the last few years and how that's impacted their business? Yeah, it's really interesting. And to your point, the catalyst was that slowdown in subscribers in 2022, right? And I'd mentioned that we had faith in management in the sense that it's a management team that's gone through challenging periods before.

And that culture of ingenuity and adaptation is a really strong set of characteristics that for me is the culture. And so one of the things we knew going in, and we've been following Netflix for a long time. So 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 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. 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 their value to you, right, as being an habitual viewer of their content.

In 2022, they started talking about restricting password sharing concurrently with coming out with a lower price. Not only is specified how low a price, so they just said an advertising driven subscription plan as well, which presumably would be lower price, potentially free.

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 ad subsidized plan. And so you pay a cheaper plan per month, and they were generating something like $10 per subscriber per month. We knew it 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. 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 because their engagement is higher, right? And the question was, what would they charge for that service? It could be...

I thought it would be about like $2.99. I didn't think it'd be free. It could be free, but I didn't think it'd be free. They came out at $6.99 at the time. I think they 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

And under new leadership, and he blessed them and all, and he admitted that, you know, maybe he was too stubborn about the advertising piece. 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 planners, just seeing password sharing, talked about 100 million people

in the world that were sharing the borrowing passwords. 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? Sometimes it's just convenience. Sometimes it's like, you know, oh, hey, we're family. So I mean, yeah, right. One person in the family pays a subscription. Why not? You know, just all kind of 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. 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. They could pay something for you. So if you're a parent with a college student, or if it like me, if it was me subscribing, my parents were borrowing from me,

I would just pay the extra bit and continue letting them borrow from me kind of thing. So I think they came out with a relatively flexible way of figuring out how to better monetize all those borrowers and change their marketing aspects around it. Obviously, it's worked out pretty well, actually. And just on this, what's really interesting to me is that there's various ways of just kind of taking a step back to his bigger picture, going back to what I think is a great business. I think great business is one that creates value for its customers.

And then the second piece of it was, how is that business able to share in that value? So what can they collect to generate returns on their business?

And 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. 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, 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 charged a little bit more, kind of faced that value along the way they're providing to their customers. I think it's a great way to model a business and build a business that has 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, 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, basically. The ad service subsidizes 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 Gaining as a free add-on. But again, another way to kind of take more of your time for

for entertainment services, come to Netflix and use their content, whether it's for video, gaming, and over time, they'll 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? That's really what this is doing. And so these are all great examples of how Netflix's culture is able to increasingly

scale the type of value it provides, which then ultimately accrues to shareholders in the value of the company that's being built. Robert Leonard I can't help but think of Munger's rule of reciprocity with regards to Netflix. I think it's a pretty good case study. I mean, 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.

There's one more point, if you don't mind. On the topic of the password borrowers becoming subscribers, I think that's been super successful from what we can tell.

So in 2022, they had roughly flat growth, right? 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. 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 was saying, this is dead. It's not going to grow anymore. And yet in 2024, just two years later, they're able to pull the levers they do to

to grow.

41 million, a record number of subscribers, which is incredible. 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 kind of a standard plan of $18 a month kind of thing.

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 to the borrowers that are converted, right? 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 going to 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. But as far as input goes, now we won't know how much of the revenue growth is subscribers versus subscribers.

which is average revenue per unit or per month, which is a combination of people paying subscription fees and advertising. My hunch is that they will tell us certain milestones. Somebody will get to 350 million or 400 million subscribers. They'll put out a press release about that. We don't know when that's going to happen, but we're not going to 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. And that's what we're seeing. But on the other hand, from a skeptical perspective, it also makes you 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 on the order of 20 million per year for a number of years, plus or minus. 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 this big event, there'd be this dip, almost like clockwork, this dip in the number of subscribers. Again, because people are busy watching the World Cup, right? Or whatever it is, right?

And any of 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.

Another good point 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. So in 2024, we saw things like them playing a couple of NFL games on Christmas Day and feedback.

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 and if there are any other initiatives that sort of stand out to what this might look like going forward.

I think at the end of the day, Netflix does want to be kind of 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 it. You mentioned earlier that they spent $17 billion on content every year, right?

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 and what kind of content they want to watch. Some like highbrow content, some like low, some like movies, some like series, some like it in one language, others like another. They did a phenomenal job of getting

getting content from around the world. Nobody else 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. That's kind of the typical Hollywood model that most other streaming services have.

But Netflix was a pioneer in trying to develop 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 on our first page when we turned Netflix on, pitching us some international piece of content they think we might like. So that brings leverage to the point of 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 going to be a huge piece of the durable value that Netflix provides as a company to people across the world.

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 the case when you're charging 18 bucks a month, right? And so they've chosen not to participate in sports in the past, but...

But as they get bigger, the scale starts to change the economics for them. And the scale of buying power changes the economics for them. 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? Kind of 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 this series that follows...

the Formula One season, but it's kind of the story behind the teams, the rivalry between teams. It's all like super interesting and fun to watch, but then it triggers your interest in Formula One too, the racing, right? And so-

Formula One is a separate company that works with Netflix to develop the 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. 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, 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, the live sports programming. Or 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 would say. I don't know. I'm just guessing, right?

And so you can see a thing where maybe Netflix can't afford or doesn't find the economic compelling to license NFL for America, but maybe they license it for live broadcast in other parts of the world. It helps NFL grow its franchise in the rest of the world, just like it did with Formula One. So I think we're going to 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 was a special event.

or the niche sort of NFL like Christmas, which apparently was a big success for them, right? You're starting to see an experiment with some of this stuff, 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 could they do something with 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 that globally distribute it,

I think then you will know they've like basically this is their capstone domination moment, right? Of like the question that you're asking.

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. 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.

How about we just kick it off? Other than maybe being more interested in cars and handbags, for example, what made you select Ferrari out of the luxury names? Yeah, it's a good name, man. You kind of hit it on the head. I've always been a car fan since my teenage years. But in general, I always have a perception that just because I'm a fan of something doesn't necessarily mean it's a good investment, right? And I remember when Ferrari used to be part of Fiat, which has a whole bunch of normal car brands in Europe. And

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, DeMonduron, 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 was like, yeah, I respect him. I think he's a good valuation guy. But at some point I saw, I think it was 2016, I saw a Morningstar research report on Ferrari. And so just out of curiosity, I was flipping through it and...

I saw this chart and it's really interesting how serendipity plays a role in certain things. But I saw this chart and it just really struck out at me. And the chart was revenue 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 they 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 3%.

7% and units were down like 4%. Here is a purely discretionary product. You don't need a Ferrari, right? I mean, maybe some of us do, 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? Which is a huge impact on your psyche, but

potentially your ability to spend or desire to spend. And that just hooked me. I was like, okay, I got to 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. And this goes to your point 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 or clients, because there's way more than 7,000 people that can afford to buy a Ferrari, even in recessions. I mean, people make money in recessions too. It just changes who makes money.

One of the clues to me about this was this chart, which then led me to look at Sergio Marchionne, who is the CEO of Fiat, whose decision it was to spin this out. And I call it a rough diamond because when you looked at the numbers, it was like, you know, pretty compelling. But he was talking about giving clues to the margins improving more towards Hermes' levels.

I noticed that they had grown units like 2%, 3%, 4% a year on average in the past. Pricing grew 3% 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. So as you analyze the company, 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 people that are worth 5 million or more. So they have 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-tenth of 1% penetration. 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. All their cars are two-door sports cars. Clearly, there was something to do there where you can make a four-door car that went fast and was fun to drive. And we saw this price gap with Porsche back in the early 2000s when they released the Cayenne. So they used to be a two-door sports car company.

The 911 was their crown jewel, right? But they weren't making much money. They were like on the verge of like collapsing with the 911 alone. They came out with a Boxster, which is a two-door sports car, but really their fortunes took off when they came out with an SUV, the Cayenne with four doors.

And at the point that I was living with Ferrari, I mean, the SUV that Porsche were selling more units, like way more units than the 911 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. 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 is just that you take the price up, you increase the desirability or the demand for it. Right. 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 5% to 10% a year on average, because the wealth of their customers was growing at that rate. When you think about their customers, they're usually tied to a business whose equity value is growing, or the equity markets that grow 7% to 10% a year on average. So you could see how they're limiting supply

But in general, the number of people who could afford a Ferrari is growing. So 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 frustration. 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 wealth, whatever the metric is, right, for aspirational. With Ferrari, I felt like they were both underpricing their products and

in the way that we're growing pricing. But secondarily, we're frustrating customers too, which is the wrong thing to do. 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, oh, I can't afford to have it, but I'm going to get there someday, 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 that 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. It was actually the first time that I had this idea 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 noticed in the business that the idea sort of solidified for me, which is that there's an ecosystem around every company, right?

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, like a Walmart or somebody, they're just like pounding on their suppliers and get the prices down, right? It's not fun to be a supplier at Walmart. But the best ones are where I have several customers. One customer suits me so well, right? They create so much value with their product. They make so much 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. The other company that reminds me of is 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 you come upon tough times,

All your stakeholders are so intricately tied to you and have such goodwill towards you. They're willing to pull much, much harder for you to get you through that tough period and keep you winning. And 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 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. One thing, just to end with, during the COVID shutdown period, it's like when you look at

and then 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're more likely to win with as a shareholder. When everybody wins, the shareholders win too.

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. 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 Ferraris. And I think this ties in well to some of the scuttlebutt research you did of attending one of their events. So how about you talk a little bit about that?

It was kind of an eye-opening moment for me because 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. And they had this customer event there where their best customers...

were invited to come see the launch, the premiere of the first of their, what they call the Icona line of limited cars. So they used to just have these hypercars like the LaFerrari, the Enzo, the F8, F50, F40 that would come once every decade, roughly. Super exclusive and only reserved for their best customers, right? So passionate Ferrari collectors also want to be the best customer because they want to be

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 hypercars called the Econa line. These cars cost millions of dollars. They invited some of their investors and Wall Street analysts to come to this customer event in 2018. And so they had the premiere launch and kind of experienced what these customers experienced when they had this premiere. It's a big show. They brought on the SP1 and the SP2

Then they had a reception where the cars were sitting on the floor. Everyone can go look at them, take photos of them, go sit in the car. But in the meantime, 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 really stuck in my head as kind of the iconic customer, right? We're just having these casual conversations while we're waiting in line. And he was probably, I'm 5'5", he's like 6'3".

He was probably in his 60s. 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 suddenly I was like, oh, so what do you think of the car? He's like, oh, yeah, I love this. This is beautiful. I was like, so do you think you might want to 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 going to cost. None of us did. Right. And so I

We knew it was going to be on the order of 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, his driver was going to be worth more.

So it's a no brainer, right? And thirdly, if you're invited to this kind of 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 just how special these cars were. I got a 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?

And he actually had a Ferrari, I think it was FXX, which is like a track-only car that Ferrari had organized to bring to the track for him to drive on the track. I mean, this is all an experiential thing. And of course, you have lunch and you have dinner. And in the process, you're meeting other peers of yours from around the world who are passionate about cars, but also successful, wealthy people.

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. So it's a really interesting 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. Yeah.

And so I think that club aspect to that network aspect is also really important when it comes to driving the value of Ferrari. It's not just the piece of art in motion that you're collecting. It's also the networking that you're doing with peers, you know, in kind of your socioeconomic group, you know, from around the world.

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One of the aspects of a business I think a lot about with many names I look at is simply just the durability. A lot of companies can execute well during the good times, but what happens when things don't go quite 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. How about you talk a little bit about that slowdown and maybe how Ferrari has fared through that?

So the short answer is, Ferrari's done great. It's done fine through that slowdown, in part because of their business model, right? So they take orders for their cars well in advance of shipment. There's a tiering system within Ferrari, right? Like the entry-level Ferraris that now cost something like $350,000 have the most units to be sold.

You know, like four or five models are kind of that entry level segment, which is sort of in the $300,000, $350,000 range. There, you're going to have kind of 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 like that customer story I relayed, right? Where that customer is a collector, you have to purchase several Ferraris 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 LaFerrari, which is like a $1.5 million car, right? And so he was like, my reputation is tarnished because Ferrari won't sell me this $1.5 million car. I deserve this.

So that kind of dynamic, you start to understand kind of 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. 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, analysts 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 with Ferrari's order books. In fact, you know, by the end of 23 to 24, it was starting to extend to 2026, their order books that were sold out through 2025, and now orders were coming in for 2026.

So it's been very resilient in part because of the way their model works. You have to understand, you could have 10 customers cancel orders for one of the higher ranking, more elite cars, and there's probably 20, 30, 50 more waiting to take their place. And that's kind of the way they manage their business. What's really interesting too is 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 100,000 euros from roughly 300,000 to about 400,000. They had raised their average selling price by 30%. 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 our customer, I had this conversation with the head of marketing there, Enrico Gallieri,

He was like, "Well, you can't just raise prices on customers. You have to give them something for it." I was like, "Well, at the end of the day, you're doing them a disservice by not pricing high enough because it rewards them for their status," which is why they're buying a Ferrari, many of them. But at the same time, it also increases the frustration amongst potential customers who can afford one but can't have one. You don't want that situation either. I don't know if it was my... And then I've written a blog about it too, the pricing issue before.

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. Whether you look at the Puro Sangwe, the SUV that went on sale, I think it was the end of 2023. That was sold out through 2025 and now it's 2026. There were estimates all over the place. I thought it would 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 a range model, which is non-exclusive, right? Because this is where they're higher volume units. Similarly, the SF90, that type of car hadn't really existed before and they came in at 550, I think roughly, and it's kind of that came in. So you can see that they're 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 a threshold with customers that accept as their pricing for them. If orders start to come in, like that order backlog came in. I mean, at this point, we're looking at 24 month backlogs, right? So it shows you just how durable their positioning is in terms of demand. They're now, by the way, at 40% EBITDA margins, which is pretty incredible from like roughly 25-ish when they went public.

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 exhausts and whatnot. Do you foresee their loyal customers being interested in purchasing EVs going forward?

It's a good question. I think nobody really knows. And maybe Ferrari might have some inkling on this. So there are 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. I think it's been coming down. And the reason why it's been coming down is they've released hybrid models. So they released the SF90 roughly four or five years ago, and then the 296 GTS and VGB a couple of 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. Both sold out their productions. Both proved that Ferrari was able to basically improve efficiency while enhancing performance with that hybrid system. So that's the key sell with Ferrari, that part of the experience is performance. It's the performance characteristics of these cars that's just incredible.

In fact, what's really interesting is that the last hypercar, the LaFerrari, was actually a hybrid as well. No one talks about it, but it was.

The question of whether an EV that they're going to launch later this year in 2025, how successful that might be, I think is a bit of a question mark. But Ferrari has a very close relationship with their customers. And so they've gotten polled and figure out what their customers might want. Having said that, Ferrari's made it very clear that at the end of the day, they're making ICE cars, they're making hybrid cars, and they're making EV cars. And they're going to let the customers decide where they fall in their...

Just as an aside, there's a newish company that kind of launched the EV supercar model called Rimac, which is now partially owned by Porsche. But I mean, they've had like amazing supercars come out. These cars like zero to 60 in sub two seconds. They're just like crazy, incredible cars. And then Porsche also came out with the Taycan, which is a,

EV, four-door EV. That was launched five years ago, roughly, and initially did really, really well, actually. They were selling something on the order of 40,000 units a year and a price point of, I think ASPs, my guess would be roughly 120, 140.

$120,000, $140,000. More recently, there's been some issues with demand around that, which has some stuff to deal with. Part of the issue that these Taycons 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. They've improved that range with the latest model Taycons. But we'll see what Ferrari does. I mean, at the end of the day, the value that Ferrari brings their customers is an

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. 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, the only electric cars to 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. 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 the different types of fuels that are used.

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. And then you're seeing some, of course, operating leverage 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?

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 in their products. I'm curious just to learn more how you think about the valuation of Ferrari.

I think of RARI's valuation the way I do all the companies 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? Because the future is unknown and uncertain. But to your point, they'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 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. 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 customers' wealth growing in the 5% to 10% range. I think pricing can grow at that range. So the point of that being that to think of like a 10%-ish plus or minus a little bit growth rate almost indefinitely at the state 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.

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, 26% EBITDA margins in 2016, roughly 40 today. And the question is, how much higher can it go? Can it get to 45? Can it go to 50? 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 evaluation should be.

And the market, I think, wrestles with that. Because at the end of the day, it's a purely discretionary product. The company basically decides what their margin is going to be and then pricing their car in that way. 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% in big top margins and kind of hold there.

And I think the valuation we're seeing incorporates some expectation of 10%-ish growth indefinitely. 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. Because the theory is that future earnings are worth less than earnings today, right? $100 today is worth more than $100 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 9%, 10%, right?

And so if you discount back future earnings, the farther out you go, the more that discount hits 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. That's the theory of it. How often that actually works in practice is a question mark, but it's one way to look at it 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 kind of what the valuation is reflecting.

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 going to be in this continuous cycle of needing to spend enormous amounts on content just to keep up with all the competition.

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. 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?

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, honestly. It's not an easy thing to do. A big part of it is stepping back and thinking about what valuation actually means. So what valuation indicates is, we touched on it when we were just discussing, it's what the market's expectations are about what the future cash flow of the company will generate.

So as a point in time, let's just take 10 years from now, right? If you were back in 10 years from today, 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? It made that transition in 2012. Being streaming first, 2015 was three years into that business.

I don't know if they 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, right?

And so to this person's point that made a point that, you know, it's hard to tell how this would work if they were having to invest so much money into content. I think she was absolutely right in doing it that way. But at that time, and this is roughly the time that I started looking at Netflix for their streaming business and what implications it would have for the media industry. What Netflix was doing was investing in their business content.

While there are companies that invest to their income statement, I don't think Netflix necessarily fit that precisely. They were investing a lot on the 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. 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

Disney overnight saying, you know what, we're going to be a streaming company because 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 graphic service,

Netflix was vulnerable in the sense that if those media companies woke up and said, "Okay, you know what? We refuse 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. 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.

And 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. 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 as part of that DVD subscription. But they licensed content from Starz for $25 million. 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.

And so it was at that point in roughly 2011 that Netflix really understood that they need to build their own content. 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. But if you're creating content, you invest upfront.

The content takes a couple of 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're needing to invest for the content that you will have in two years to support that revenue. And so that's something that Netflix went through. And now we're at the point where if you look at their amortization, which is kind of the expensing of content, it's half licensed, half their own. And the reason why media companies didn't cut off Netflix is because

This was old content. They were licensed to Netflix. They advertised it, depreciated it already. It was essentially 100% margin revenue, like hundreds of millions of dollars at 100% margin. It's really hard to say no to, right? Even though you're feeding the devil that's going to destroy you potentially in the future, right? So if you look at Netflix at that time, the valuation looked expensive because it was investing. The investing in the income statement was in building out that global network. So remember, they're deploying servers there.

They're partnering, they're creating content for new markets that aren't really generating that revenue. Because this is one of the things where you have to build it first, then you get attraction from consumers to your service because the product is the content. So I have to make Korean content for most Koreans that 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 whatever it is, right? And so there's a bit of a faith in the process. There's a bit of a guessing game

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 at

I think at the time it was maybe 10%. Will it be 10% going forward? Will it be 20, 30, 40, 50? I don't know. One thing you do is look at media companies. Again, at the time, 2015. Today, 2015, you look at media companies, their operating margins were in the high 20s, roughly, maybe low 30s for Disney, perhaps. They were probably the most profitable one at the time. And so you get some idea that, well, if this is a good business, which I think it could be, then operating margins could look like this. Turns out,

That's kind of how it played out over the last 10 years, where now Netflix's management says that they printed 27% margin-making last year. And 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 because it's the first time that the content business is a global scale business. We've not seen that before. It's a regional scale. And 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 that go into it. But the short answer is it's hard. But the key leverage 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, 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? But

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 so today is the probability the team, the people can execute on the plan.

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 are the three drivers of valuation generally.

Wonderful. Well, we didn't have time to get to service now today, but as always, I appreciate you going so in-depth here on Netflix and Ferrari. 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?

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. But yeah, would love to connect with anybody that's interested. Wonderful. Thanks a lot, Arif. Really appreciate it. And hope the listeners enjoy this conversation. Thanks so much, Clay. Appreciate it.

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