As the Second World War came to an end, everyone started to rebuild.

For Japan, that rebuild was one of the greatest periods of growth…ever!

After the war, Japan catapulted to the second largest economy in the world.

The Japanese system (Japan Inc.) was foolproof. And it would make them the richest people on Earth…

‘…if we had been sitting here in 1989, everybody thought the United States was going to consist of people who flipped burgers at Disneyland for Japanese tourists.’

That’s how former Columbia Business School professor Bruce Greenwald put it.

We all found out later that Japan’s economic miracle wasn’t sustainable.

Now in 2019, Japan struggles to grow their economy by more than 2% a year.

The nation wallows in debt. The government continues to issue more of it. Japan’s aging population makes a bleak future look even more so.

Their strategy to print their way out of problems hasn’t worked so far. And I don’t believe it will anytime soon.

Japan needs to make some structural changes. If they don’t they’ll be left severely disappointed, much like the investors buying Netflix, Inc. [NASDAQ:NFLX] today.

Japan is competing in a dying industry

Japan is a very interesting case.

How did they come out of the war so strong, yet today are anything but?

I believe it’s because Japan turned themselves into a manufacturing powerhouse. And that cornered them into a box, which would come back later to hurt them.

It first started with autos.

Japan had Toyota, Nissan and Isuzu. All three took technology from the war, borrowed heavily from banks and competed with the big American auto makers in Detroit.

Shortly after, many other industries followed. In the second addition of his book The Making of Modern Japan, Kenneth Pyle wrote:

‘Nationalism and the desire to catch up with the West persisted after WWII, but now the efforts were focused on economic and industrial goals. For example, machine gun factories were converted to make sewing machines; optical weapons factories now produced cameras and binoculars.’

And with the rest of the world gobbling up Japan’s exports, businesses become rich, using earnings to reinvest in new plants and technology.

They became more efficient at producing. And thus Japan’s miracle was based on global demand for exports.

Japanese businesses grew confident. They took on more debt.

Corporations were still awash with cash. They turned to speculation, whether that was on stocks or real estate.

Japanese assets started to rise, including their currency.

An appreciating currency is bad for exporting nations as it makes their goods more expensive. Japan couldn’t have this so they cut interest rates to lower their exchange rate.

This just pumped more cash into an already frothy economy.

Then Japan cut corporate and marginal income taxes (go Japan!).

But there was simply way to much cash circulating the system. And it led to extreme asset prices, especially for property. Housing Japan writes:

‘It was said at the time that the value of the Imperial Palace in Tokyo exceeded the value of all real-estate in California (which is some of the most expensive around). Land in Ginza 4 Chome was reported to have trades at JPY 90,000,000 (US$750,000 at the time) per square meter.’

So what stopped Japan’s miracle (and also popped their asset bubble)? Finite demand for manufactured goods.

No matter how much stuff you produce, demand for it is not unlimited. And of course it was only a matter of time before things came crashing down.

Prices could not be sustained. Manufacturing growth was not sustainable. Now the Japanese are finding out how hard it is to compete in a dying industry.

And like the Japanese real estate investors in the 1990s, it will be Netflix buyers soon left with sorrow and regret. [openx slug=inpost]

 

The future of Netflix

The US earnings season is basically here.

This is when a swath of US businesses announce quarterly earnings and comments on the near future.

Netflix will be one of those businesses. And there is huge dispersion among near-term expectations. From the Australian Financial Review:

‘You only need look at the range of price targets issued by the 38 analysts who cover the stock to realise this is one of the most divisive internet stocks listed on the Nasdaq exchange. The lower end of the price target range is $US120 and the upper end is $US480, according to S&P Capital IQ.’

So who are these people buying the stock?

A lot of them are fundies. The prize for destroying conventional TV is so great that it’s worth taking the risk, they say.

The AFR continues:

‘Buying the stock requires investors to abandon any adherence to conservative valuation principles. The stock trades at 80 times its 2019 earnings, 50 times its 2019 earnings before interest, tax, depreciation and amortisation and seven times its 2019 revenue. It arguably carries the most extreme valuation of all internet stocks with a market capitalisation in excess of $US10 billion.’

To the bulls, Netflix is still a growth company. The people over at Morgan Stanley believe Netflix has an addressable market of 660 million-plus subscribers.

Right now, Netflix has about 117.5 million subscribers.

Multiply 660 million by Netflix’s average monthly streaming cost of US$10.23 and that’s US$6.75 billion in sales a month.

In a year, that’s US$81 billion in sales. Using their last annual profit margin, Netflix might earn US$4.1 billion from those 660 million subscribers.

And even with these optimistic assumptions, Netflix trades on a price-to-earnings ratio of 35-times future earnings.

What are they going to do? Grossly raise the price of a subscription?

If that’s their hope I don’t think they’ll pull it off.

The streaming business could become extremely competitive. Netflix and others are benefiting while the industry continues to grow.

But what happens when that industry matures? What happened when the world is saturated with on-demand video streaming?

Will Netflix own all of it?

Of course not.

They’ll compete with others, likely on price. That means they probably won’t have pricing power. The dream of increasing subscription prices by 10 bucks a month will likely lead to lots of cancellations. Why pay double for Netflix when there are other providers that have more or less the same content?

Netflix is already up 26% this year. If subscriber numbers look good, the stock will probably continue to climb.

But those investors buying Netflix now are neglecting what could happen in the near future. Netflix could be to streaming what Apple is to smartphones.

Both are top notch, user friendly and cost a whole lot.

But even Apple can’t dominate smartphones with their brand and lifestyle appeal.

How is Netflix going to do the same for streaming?

Buy a subscription not the stock,

Harje Ronngard