How Netflix paved a cash-filled road to streaming dominance

Television company had revenue of $14.9bn in the last year

The company’s market capitalisation currently stands at approximately $156 billion. Photograph: Reuters

The company’s market capitalisation currently stands at approximately $156 billion. Photograph: Reuters

 

Here are some notable numbers from Netflix:

130 million paying customers as of September

$14.9 billion in revenue in the last 12 months

$1.3 billion in profit for the same period

7.6 million more paid subscribers expected to be added in the last three months of 2018

23 Emmy Awards this year, the same as HBO

Here’s another: $18.6 billion.

That’s the amount Netflix has committed to spending on content, including many shows that won’t show up on the service for months or even more than a year, such as new seasons of The Crown and Stranger Things and the much-anticipated lineup from the super producer Shonda Rhimes.

It’s also far more than what traditional players such as Walt Disney, HBO or NBCUniversal generally spend on entertainment. But that’s why investors are mad for Netflix. They’re betting on its unorthodox media model: spend big now and reap a massive subscriber base (and big profits) later. Possibly much later. The service’s current tally of 130 million customers beat Wall Street estimates, but investors are ultimately counting on 300 million, or more.

The size of that number explains why Netflix is valued so highly relative to other entertainment businesses. The company’s market capitalisation currently stands at approximately $156 billion. Disney, by comparison, is valued at about $174 billion.

Those figures look out of whack when comparing the size of the companies. Netflix had $14.9 billion in revenue and $1.3 billion in profit for the last 12 months. Disney generated $58 billion in revenue and $10.1 billion in profit for the 12 months ending June 30th. (Disney won’t report results for its most recent quarter until November 8th.)

In other words, Disney made eight times more money than Netflix, but it’s only worth about 12 per cent more. Another way to consider it: Netflix investors are paying about $120 for every $1 of profit it generates. For Disney, investors are paying about $17.

Why everyone is trying to copy Netflix

Netflix is the streaming pioneer, but it’s about to get some serious competition. Disney, led by Robert Iger, has already introduced a streaming sports service, ESPN+, and will introduce an entertainment offering next year. The company also spent $71.3 billion for most of Rupert Murdoch’s media empire, including the 20th Century Fox movie and television studios, a set of cable networks and – critically – a controlling stake in the streaming service Hulu. Disney will soon be able to sell access to films such as Black Panther, Avatar, and the original Star Wars trilogy directly to home viewers without having to go through Netflix.

Laura Ricciardi, left, and Moira Demos, the creators of “Making a Murderer” Photograph: The New York Times
Laura Ricciardi, left, and Moira Demos, the creators of “Making a Murderer” Photograph: The New York Times

Netflix is also part of the reason AT&T spent $85.4 billion for Time Warner – renamed WarnerMedia – which will unveil a new streaming service built around HBO by the end of next year. Those astronomical deals put Netflix’s $18.6 billion content spend in a slightly different light.

“There are so many competitors,” Reed Hastings, Netflix’s chief executive, quipped on an earnings call on Tuesday.

“Disney’s going to enter. AT&T is going to expand HBO. YouTube is on fire. And there’s video gaming like Fortnite. There are so many ways to have great entertainment on the screen.”

Hastings acknowledged Netflix eventually will have to compete against all kinds of subscription services, but “it seems very far-off from everything we’ve seen.” He added that as more media companies start selling directly to consumers, traditional TV networks will have to focus on news and sports to thrive.

How does ‘negative free cash flow’ work for Netflix?

Netflix’s appetite for content means it has to spend big, resulting in what’s known as “negative free cash flow.” More money is going out the door than coming in, a difference that Netflix covers by borrowing even more. But Netflix can also show a profit because accounting rules allow entertainment companies to record most of its production or licensing costs later on. A show such as Stranger Things, entirely funded and owned by Netflix, costs as much as $8 million per episode. Netflix pays for all of that up front, but the cost isn’t counted until the show is available on the service, often a year or more after production. The next season is expected to be released in the summer of 2019.

Multiply that by the hundreds of hours of original content Netflix produces every year, and the cash starts to bleed out. The company had negative free cash flow of $2 billion last year. It expects that figure to rise to about $3 billion this year and about the same next year.

Olivia Colman, who is replacing Claire Foy as Queen Elizabeth II in the hit Netflix drama, ‘The Crown’. Photograph: Netflix/PA
Olivia Colman, who is replacing Claire Foy as Queen Elizabeth II in the hit Netflix drama, ‘The Crown’. Photograph: Netflix/PA

For Netflix, it’s all part of the plan. An aggressive content strategy fuels a successful marketing strategy that leads to more subscribers. (There is also mounting debt.) Promoting House of Cards, now in its final season, was “really about selling Netflix,” Ted Sarandos, the chief content officer, said on the call.

“It’s getting people excited about seeing something they can only see on Netflix.”

Why content is, and will remain, king

The “you can only see it on Netflix” model has also fuelled the creation of competitors’ services. That could lead to a content cold war in which studios discontinue licensing shows and films to other outlets in favour of their own streaming services.

Disney, for example, plans to pull its Marvel films such as Black Panther and The Avengers from Netflix once those licences start expiring next year. Viewers will likely have to go to Disney’s new streaming service or Hulu to watch those movies. AT&T is likely to do the same with its blockbuster features such as Wonder Woman, or hit series such as Friends, once those syndication rights start expiring. That means less content will be available to Netflix. But it also means Disney and AT&T will have to forgo billions in potential licensing fees. That revenue may be difficult to make up with a streaming service that costs $10 or $20 a month.

It might explain why Hastings doesn’t seem too bothered by the competition. “That’s going to make it exciting for us,” he said. “It’s great for consumers. Incredible for producers. I mean there’s never been so much TV and movies being created around the world. So the game is on.” – New York Times service

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