Hopefully, this article will be more thrilling than the latest show you binge-watched on Netflix. Bill Ackman, a famous activist shareholder, announced on January 26 that Pershing Square acquired more than 3.1 million shares of Netflix in a 1.1-billion-dollar transaction. As a top-20 shareholder in the company, Pershing Square is now “all-in on streaming” and believes in the long-term growth of this industry. Looking at the big picture, this transaction compliments a growing sentiment that regulators should incentivize investors to base their decisions on long-term trends instead of short-term profits.
In 2020, Netflix’s stock price gained more than 60%. However, this price surge was motivated by the pandemicand increased media consumption causing 37 million new subscribers to join the platform. In other words, Netflix’s stock price was driven by a temporary event rather than a long-lasting growth opportunity.
However, investments for short-term profits increase the volatility of our financial markets. Studies even find that they might cause a “price distortion, or bubble.” For example, Netflix suffered a 23% backlash when its annual subscriber growth suffered a downturn in 2021. Short-term investors probably did not account for encouraging signals, such as Netflix winning most Emmy awards in 2021 or Squid Game, which launched in 2021 and proved to be the most successful show on the platform.
On the other hand, value-driven investors were not deterred by Netflix’s slower subscriber growth in 2021. They are motivated by long term profits and took advantage of pessimistic reactions. As Ackman noted in its letter to investors, the “opportunity to acquire Netflix at an attractive valuation emerged when investors reacted negatively to the recent quarter’s subscriber growth and management’s short-term guidance.”
Pershing Square’s financing of the transaction also demonstrates that investors continuously balance short- and long-term interests. Ackman’s letter explains that the transaction was financed with $1.25 billion proceeds from an interest rate hedge. He notes that Pershing Square “could have likely realized more gains” with this interest rate hedge, but Netflix “offered a more compelling risk/reward and likely greater, long-term profits for the funds.”
Many investors would have probably stuck to the short-term profits from the interest rate hedge. In a reportfrom 2018, Nasdaq already observed a concerning “trend toward exerting pressure for short-term gains at the expense of long-term health.” The same pressure for short-term gains is probably behind the price increase of your Netflix monthly subscription. Indeed, short-term pressure pushes managers to immediately deliver results instead of focusing on value creation. A study by Graham, Harvey and Rajgopal found that “managers appear to be willing to burn ‘real’ cash flows for the sake of reporting desired accounting number.” Interestingly, their study notes that 80% of the managers would “decrease discretionary spending on R&D, advertising and maintenance to meet an earnings target.”
In the case of Netflix, slower subscriber growth means less revenues than expected. Managers could thus be tempted to spend less on content development to meet their earning targets. This might be good news for some of us desperately trying to stop spending countless hours on the platform, but less quality content would hurt Netflix’s growth in the long run. An alternative would be to increase subscription prices to generate higher income and meet earning targets. Managers implemented this option on January 14, 2022 and the stock price went up.
Similarly, Almeida, Fos and Kronlund found that companies generally buyback their shares to meet earnings per share targets. Netflix probably implements this strategy too. For example, a Forbes article from 2021 announced “Netflix Shares Plummet After Q1 Subscriber Miss, But Buybacks Coming.” This demonstrates that short-term investors and market volatility constrains managers to focus on accounting rather than improving products and business strategies.
This short-term pressure will not only prevent you from enjoying Netflix shows at $8.99 per month—it has broader implications. Indeed, corporations are currently expected to become more inclusive and to reduce their environmental impact. Implementing these changes requires substantial investments potentially reducing short-term returns. But if investors continue to focus merely on quarterly earnings reports, managers will more likely save their balance sheet rather than our planet. Regulators might thus have a role to play. For example, the SEC requested comments on the timing of earning releases and scholars suggested to allow shareholders to vote only after holding shares for a certain period of time. Hopefully, regulators will find effective ways to encourage investors to focus on long-term growth, like Bill Ackman in his Netflix acquisition.