Netflix (NASDAQ: NFLX) has fundamentally changed the way we watch TV, and in the process created the world’s greatest recurring revenue machine. Nevertheless, despite the eye-popping results, and linear TV’s tailspin, the streaming leader is not as stable as you’d think.
Netflix started 2017 by missing their Q1 subscription targets, but Q2 and Q3 brought crushing numbers pushing the stock up 45%. The short sellers have taken a beating in 2017, losing a reported $1.4 billion, but with the stock losing 4.5% to end the week (Dec 1/17) perhaps a reckoning is coming.
While their subscription model is still a beast, and Netflix is the undisputed king of fomo content, here are some of the compelling reasons to be bearish:
Business Model. Unlike the diversified members of ‘FANG’ (Facebook, Apple and Google), Netflix is primarily a one-dimensional service business. They’re an aggregator licensing the vast majority of their content, what they do create is expensive and doesn’t generate residual revenue (outside their own service), and they’re reliant on a delivery system (ISPs) that is gearing up for an assault on their margins.
Licensed Content. Netflix sells access to content, some licensed, some original. Licensed content, mostly from TV networks, was the original selling point of the service, however the struggles of networks means the volume of “hits” is in decline, meanwhile past content has a stale date as consumer tastes change. However, perhaps most notable is that the content creators, who were eager to cash the big Netflix checks, now recognize their contents’ value, so prices will increase, or in Disney’s case, the content will be reacquired for their own competing service.
Original Content. Netflix has created some exceptional television shows. It is easy to see their current strategy is to bankroll brilliant storytellers and show runners, but it is not that simple… creativity is not a constant or commodity. As much as they want to corner the market on talent, the history of Hollywood and television is littered with massive losses on can’t miss projects.
To put a finer point on it … how many Netflix originals can you name? Maybe five? They have over 80 originals available in 2017; and while there was a lot of cheering when they received 91 Emmy nominations, 60% were for only two shows: Stranger Things, and the largely unknown (unwatched?) The Crown, which cost a whopping $130 million for ten episodes.
Netflix is betting $7-8 Billion on content in 2018, with “$17 billion in commitments over the next several years” (letter to shareholders). A standard linear network spends about $4Billion annually, and for an OTT example Amazon spent $3.5billion, while HBO spends $2Billion.
There is optimism from all of us who love TV that Netflix will continue to produce breakthrough original shows that captivate us. But while spending has been the reward for past success, it is rarely the fuel for creativity, in fact it can often create complacency and bland results.
The near future for Netflix includes big challenges on many fronts: significantly higher costs, more competition, declining access to quality product, delivery obstacles and the potential for massive losses on original product. They’ve got a great head start, and a solid revenue engine, but maintaining dominance is going to be tough… just ask Kevin Spacey.
So what does Netflix do?
The most dramatic scenario is Apple will buy them … but it will “cost” them about $100Billion, and while it seems like a no-brainer, given the coming challenges the jury is still out on the business case.