Netflix – fighting the other internet giants for content
The New York Times reported recently that Netflix (NASDAQ: NFLX) is intending to spend $7-8bn on content next year. In their Q3 earnings report, the company stated that “our future largely lies in exclusive, original content”. The market was very comfortable with this strategy – the stock maintained the $200 level it had reached a few days previously.
The company made $2.99bn in the third quarter of this year, a 30% rise from this time last year. Crucially, it increased subscribers by 850,000 in the US and 4.45 million in the rest of the world – and the company’s pipeline of content commitments currently stands at $17bn.
Netflix has raised its prices to users to help pay for this content bonanza, and this may have been responsible for the slight slowdown in the growth of subscribers, compared to last year.
Stiff competition for content
Netflix is currently outspending both CBS and HBO. It now spends 25% of its content budget on original programmes, and it expects that percentage to increase. With both Amazon and Facebook having similar content strategies in place, there’s surely never been a better time to be running a film or media production company.
But while Facebook doesn’t have any serious competitors for its advertising platforms, Netflix will have to fight the competition to secure the best content. Comcast, Disney, Time Warner and 21st Century Fox are all parent companies of Hulu which is now intent on developing more original content. Disney is intending to pull its movies from Netflix and offer its own streaming service, while Apple is now sending a “me too” message to Hollywood – it’s intending to start off with a $1bn investment in original content.
Higher content budgets will translate into higher profits for makers of video, film and programme content. And the sheer volume of video, film and programme content that will be required to fuel the needs of these gigantic companies offers amazing opportunities to creative talent in the media and entertainment industries.
A host of related companies, such as those providing production facilities or special effects can also be expected to share in the growth.
Netflix prepares to secure its content stream
The Disney move to keep its content on its own platform may be followed by other high-profile entertainment names. Netflix is clearly aware that licensing content from its owners is a higher risk business strategy. It wants its own content, so that it has a secure and predictable base moving forward. It has said that it intends to have its own library made up of 50% original film and TV content, by next year.
The huge budget for buying this content shows how serious Netflix is. Ted Sarandos is the Chief Content Officer and he’s said that he wants to see 80 new films and 30 animated series released in 2018. Animated content is easier to adapt for overseas markets, but Japanese content has also been successfully streamed in the US. This move helps Netflix embed itself as a platform with younger viewers who have been using alternative streaming services to view manga and anime content. Netflix has actively been helping film studios and production companies which have content it’s interested in.
Forbes reported last year on a Morgan Stanley poll that showed Netflix ahead of any other pay TV or internet subscription content provider. HBO was second, and Amazon was way lower.
Investment and lending being targeted at media companies
In parallel with the competition for content, private and corporate finance have seen the opportunities in the video, film and media sector and are competing to lend money to film production companies, now regarded as a much better bet given the booming market for the creation of original content.
Barclays has taken a look at the way the internet giants do business and spotted an opportunity for bridge financing. Netflix, for example, sometimes staggers payments to content producers, unlike traditional TV companies who typically pay for programmes on delivery. While producers may be better off with Netflix in the long run, they need cash to keep running while they wait for the profits to come in.
The media section of Barclays corporate lending arm, has set aside £100m in a new “Subscription Video on Demand” fund. This will provide interim finance to programme makers, and help them smooth out cash flow by selling receivables to the bank.
It’s another sign that the battle for original content has barely begun.
Netflix promotes in-house management talent
Netflix CEO Reed Hastings has a reputation for being decisive, and there have been some changes at Netflix recently. Longstanding Chief Product Officer, Neil Hunt retired and Tawnie Cranz, Chief Talent Officer, left “to pursue other interests”.
Neil Hunt has been replaced through internal promotion – Greg Peters who has worked for Netflix for nearly ten years, has taken over. The company seems able to nurture homegrown executive talent. Jessica Neal, another Netflix insider, has been promoted to Chief Talent Officer. David Wells, Netflix Chief Financial Officer, has been with the company for seven years.
Meanwhile Ted Sarandos, Chief Content Officer, remains at the top of his game, showing an ability to attract talent such as Shonda Rhimes (Grey’s Anatomy, Scandal) to join Netflix from rival media organisations.
Netflix’s Q3 results show a 33% increase in global streaming revenue with operating margin at 7.0%, exactly on the company’s target. However earnings per share (EPS) were disappointing at 32 cents with adjustments, against expectations of 37 cents. The company doesn’t pay a dividend and won’t do “in the foreseeable future”.
Despite strong performance, worries over debt
Currently trading at around the $185 mark, the stock has risen from $122 a year ago and has been as high as $200. The current stock price puts Netflix on a price/earnings (p/e) ratio of around 190 with a current market capitalisation of $81.59bn.
However some investors are clearly worried by the amount of debt being carried and the fact that the company has a negative cashflow. In 2014 debt was below $1bn. It’s now $5bn with roughly $2.5bn of negative cash flow. Solvency ratios, such as debt-to-equity have deteriorated since 2014.
The company’s explanation is that it has to pay for content in advance but the content then becomes a balance sheet asset with the cost amortised (gradually written off) over time. This is a reasonable strategy but investors should watch the debt figure when they look at the Q4 results.
Meanwhile, management ratios such as Return on Investment are fairly volatile but Netflix ROI is currently in the region of 5%, which is isn’t bad, if it can be sustained.