How Bill Ackman Lost $400 Million in 90 Days

Billionaire investor Bill Ackman recently lost 400 million dollars in less than 90 days, and in this video, we're going to talk about what happened. Ackman is one of the most closely followed and highly respected investors on Wall Street, and rightfully so. His fund, Pershing Square, has generated billions of dollars in profits for its investors. But for as much success as he has had, Ackman has also had his fair share of misses. This included losing a whopping 3 billion on an investment in a company called Valeant Pharmaceuticals, as well as a short bet on Herbalife that didn't go his way.

He added to this list of bad investments recently with his investment in streaming company Netflix. Ackman’s fund lost a staggering 400 million dollars on this investment that he only held for three months. Now, don't get me wrong, I have a ton of respect for Ackman and obviously think he's a great investor. I make videos explaining his strategy and diving into his different investments and investment strategies so that we can learn and improve our own investing skills. So, I only think it's fair that I also examine this Netflix investment that didn't go so well, so we can learn from it and hopefully avoid making similar mistakes.

Ultimately, the goal of studying prominent investors' mistakes is to help us avoid losing money in our own investments. To paraphrase investing legend Charlie Munger, one of the best ways to learn is from mistakes, and it's even better when you can learn from the mistakes of others. Learning from others' mistakes is cost-free. If you can learn from other investors' mistakes, you don't have to learn the same lessons with your own money. That's what we are going to do in this video. We are going to examine why Ackman invested in Netflix, what went wrong, and what you can learn from this investing mistake to apply to your own investing. Now, let's get into it, but first make sure to give this video a like because my goal is to help make you more knowledgeable and a better investor. You guys are great. Now let's jump into the video.

One of the great things about starting Ackman's investment is that he clearly laid out why he bought Netflix, and then after he ended up selling, he put out another letter explaining how he came to that decision to sell. Despite its relatively recent struggles, Netflix has been one of the best-performing stocks of all time. You could have bought the stock on a split-adjusted basis of 47 cents in October 2002, shortly after its IPO. That same share would have been trading as high as 690 dollars in October 2021, 19 years later. If you had invested ten thousand dollars in Netflix in October 2002, that ten thousand dollars would have turned into 14.7 million dollars in October 2021. That would have been quite an impressive return on your investment over the years.

Netflix has evolved from a mail-order DVD rental business to the world's largest streaming company, spending tens of billions of dollars on developing original content along the way. Netflix's growth as a company and its stock returns for investors led to it being one of the so-called FAANG stocks—these stocks are Facebook, Amazon, Apple, Netflix, and Google. Quite an impressive list of companies for Netflix to be included among. However, starting in late 2021, Netflix's stock price came under pressure. There were multiple factors at work, both specific to Netflix as a company as well as things impacting the broader stock market.

One of the things putting downward pressure on Netflix's stock, as well as the stock price of other high-growth companies, was rising interest rates. I could make a whole video on this topic alone, but it's important to understand the impact interest rates have on stock prices. All else being equal, as interest rates rise, they decrease the value of a company, and as a result, decrease that company's stock price. Now, rising interest rates impact the value of all stocks, but certain companies suffer more. Companies that aren't currently profitable but are growing fast are impacted more by rising interest rates than profitable, steady, and slow-growth companies. Netflix falls into the category of a not-yet-very-profitable but fast-growing company.

While Netflix wasn't currently making enough money to justify its market cap at the time, investors were excited about the company's future growth prospects and the cash it would be able to generate years into the future. However, as investors started to worry about rising interest rates, the share price of Netflix and all other high-growth tech companies began to fall. In addition to this, Netflix also had its own challenges. For years, Netflix dominated the streaming industry. If you wanted to watch popular TV shows and movies whenever you wanted, Netflix was really the only choice. That has changed in recent years, as it seems like nearly every company has introduced some type of streaming service. This rising competition has been called the streaming wars. There are services like Disney Plus, Hulu, HBO Max, Apple TV— even cable news organizations got into the mix with their own streaming services.

All of these different newly-formed streaming companies are spending billions of dollars developing original content. Additionally, many of these streaming companies are part of large, highly profitable companies already. This means that they are willing to have low prices to encourage customers to sign up, even if that means losing money for multiple years as their streaming platform gains scale. All of this made for a much more competitive industry for Netflix to operate in. Investors became concerned that Netflix wouldn't be able to grow subscribers fast enough due to this competition. This sent shares plunging down from a high of around 690 a share in November 2021 all the way down to around 390 per share just a couple of months later in January 2022.

So, all these factors set the stage for Bill Ackman to invest. Throughout his career, Ackman has invested in otherwise great companies that have stumbled. When these companies stumble, so does the stock price, giving Bill Ackman a buying opportunity. In fact, some of his best investments have come about that way. In 2016, the restaurant brand Chipotle was struggling. The company had been dealing with food safety concerns in its restaurant. Cases of E. coli and norovirus popped up at Chipotle restaurants around the country, leading to a steep drop in sales and profits. With the company unable to recover quickly, investors spent the year selling off the stock. However, Ackman viewed all of these problems Chipotle was facing as "fixable," meaning that these problems were just temporary issues and the business's long-term future looked bright. Long story short, Bill Ackman bought nearly 3 million Chipotle shares. The stock has more than tripled from when Ackman bought it, making himself and his investors over a billion dollars in the process. In fact, Ackman still holds 1.1 million shares of Chipotle currently, making up around 20% of his current stock portfolio. Ackman viewed Netflix as another Chipotle type of investment, a company that had a temporary speed bump but was otherwise a great business.

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Okay, now back to the video. One reason why I like studying Bill Ackman is that he is very transparent on why he makes certain investments. In his letter to investors, Ackman laid out his investment thesis, or to put it in simpler terms, why he liked the Netflix stock. This thesis centered on two main elements: subscriber growth and pricing power. Netflix operates a subscription-based business model. This provides a company with what is referred to as recurring revenue. Investors love the so-called recurring revenue, and let me explain why.

In most businesses, when a company makes a sale to a customer, that is the end of the relationship between the company and the customer. Obviously, the company hopes the customer will eventually return to buy another product or service, but that is far from guaranteed. Most companies have to spend money on advertising and promotions in order to attract that customer back to the store to shop again. With a subscription model, you make your sale once by getting the customer to sign up and enter their payment information, and you're able to have a sale from that customer every month. You do the hard work of getting the customer to sign up, and that customer will be a customer every single month, likely for years. The benefit of the subscription model is that revenues tend to be much more consistent and predictable.

Additionally, customers tend to be what is referred to in investing as sticky. Meaning, once they sign up, even if they don't regularly use the service, they still don't often cancel their subscription. You don't have to be a Harvard graduate like Bill Ackman to see why a subscription business model can be so powerful. In a subscription model, obviously one of the most important metrics is subscriber growth. Ackman's thought process was that Netflix would be able to continue to grow its subscribers despite the streaming wars that we discussed earlier. However, this turned out to not be the case. On April 19th, Netflix released their results for the first quarter of the year, and they were not good at all. For the first three months of 2022, Netflix lost 200,000 subscribers—the first time the company actually lost subscribers in 10 years. Even worse, the company said that over the course of the next three months, Netflix will likely lose another 2 million subscribers.

As I'm sure you can imagine, this was not good news to investors. Investors sold the stock in droves, driving the price of the stock even further down. One of those investors who sold was Bill Ackman, and he dumped his entire stake in Netflix after this announcement, resulting in a loss of 400 million dollars. For years, Netflix has been spending tens of billions of dollars on advertising as well as developing its own original content. The thought being that if Netflix is able to amass hundreds of millions of subscribers, it can then pull back on its advertising spend and generate a ton of cash flow from its subscriber base it has generated. The fact that Netflix is actually losing subscribers while still spending billions on advertising and original content completely flips that thinking.

The next key part of Ackman's thesis centered on pricing power. This is a concept where a company can raise its price without much pushback from customers. For subscription business models, the revenue equation is simple: take the number of subscribers and multiply that by the amount each subscriber pays. This gets you the revenue the company generates. Ackman believed that Netflix had enough of a competitive advantage that it could charge more than competitors and not lose subscribers as a result. The monthly cost for Netflix’s standard plan is 15.49 a month. That compares to 7.99 a month for Disney Plus and just 4.99 for Apple TV. For years, Netflix was the only game in town when it came to streaming, so Netflix wasn't competing against other streaming companies. Netflix was only competing against cable.

Relative to cable, Netflix has a ton of pricing power. A basic cable plan starts out at around 60; Netflix costs just a fraction of that. Relative to cable, Netflix could raise its price 10%, 20%, even 30%, and the cost of Netflix would still be substantially less than that of cable. This is what investors were betting on—that over time, Netflix would be able to dramatically increase the price part of the revenue equation that we discussed earlier.

However, given Netflix's results in recent months, Netflix's pricing power may have just disappeared due to the rise of other streaming platforms. Because there are so many options for consumers when it comes to streaming now, Netflix no longer just has to compete against cable; the company also has to compete against other streaming companies, many of which offer lower prices than Netflix. Because there are so many streaming companies, this limits how much Netflix is able to raise its prices. In light of these changing dynamics, Bill Ackman decided to sell his stake in Netflix after holding it for only a few months.

Here's what he had to say: "While we have a high regard for Netflix's management and the remarkable company they have built, in light of the enormous operating leverage inherent in the company's business model, changes in the company's future subscriber growth can have an outsized impact on our estimate of intrinsic value. In our original analysis, we viewed this operating leverage favorably due to our long-term growth expectations for the company. Yesterday, in response to continued disappointing customer subscriber growth, Netflix announced that it would modify its subscription-only model to be more aggressive in going after non-paying customers and to incorporate advertising—an approach that management estimates would take one to two years to implement. While we believe these business model changes are sensible, it is extremely difficult to predict their impact on the company's long-term subscriber growth, future revenues, operating margins, and capital intensity. We require a high degree of predictability in the businesses in which we invest due to the highly concentrated nature of our portfolio. While Netflix's business is fundamentally simple to understand, in light of recent events, we have lost confidence in our ability to predict the company's future prospects with a sufficient degree of certainty."

So now we understand what happened to Netflix and why Bill Ackman ended up selling this talk. I want to spend the rest of this video talking about the lessons we as investors can learn from what happened with Bill Ackman and Netflix. One of the biggest challenges for all investors, whether you are like Ackman and running a multi-billion dollar fund or investing your savings from your first job, is the question of when you should sell a stock. Looking at Ackman's Netflix investment can give us some perspective on how to approach this challenging question. From studying investors like Warren Buffett, Charlie Munger, Monish Pabrai, Peter Lynch, and Bill Ackman, I'm a huge believer that the only way to truly produce strong investment returns is to be a long-term focused investor.

However, as long-term investors, we have to walk a very fine line between holding out to a stock through swings in the stock's price, but also be willing to give up and sell if the underlying fundamentals of the business have changed. Being able to sell when your investment thesis turns out to be inaccurate and admit defeat, if you will, is a very important skill. The quicker you learn it, the better off you will be as an investor, and likely the more money you will have in your investment account. This is a skill Bill Ackman did not always have. In 2015, Bill Ackman started to build a position in the pharmaceutical company Valeant. Once a darling of the stock market, Valeant had appeared to be changing the business model for the pharmaceutical industry with its relentless acquisitions. But questions over its aggressive accounting and the political fire over its drug pricing on top of its huge pile of debt caused many investors to leave the stock. However, Bill Ackman hung onto his shares. In hindsight, it was clear that Valeant's underlying fundamentals as a business were permanently impaired. Despite this, Ackman held on, hoping for a turnaround. Had Ackman been willing to walk away once it was clear that the fundamentals of the business had changed, he would have avoided some disastrous losses. Ackman lost 4 billion on his investment in Valeant. This investment fueled losses in Ackman's main fund of 16.7% in 2015 and 10.2% in 2016. Assets under management Ackman's Pershing Square hedge fund firm dropped from more than 20 billion dollars in the summer of 2015 to 11 billion dollars, and Ackman fell off the Forbes 400 list of richest Americans.

It was clear that Bill Ackman learned his lesson, and he was willing to walk away from Netflix when the underlying fundamentals of the business changed. Now, like I said at the beginning of the video, this is not meant to be a criticism of Ackman at all. Instead, remember what Charlie Munger said: it's important to learn from your own mistakes, but it's even better if you can learn from the mistakes of others. I hope you enjoy the video. Make sure to give this video a like and subscribe to the Investor Center because my goal is to make you a better investor by studying the world's greatest investors. Talk to you next time.