Narrative: Netflix is Spending Too Much on Content
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Narrative: Netflix is Spending Too Much on Content (Jan 28, 2017)
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Hulu Will Spend $2.5 Billion on Content in 2017 (Sep 14, 2017)
Netflix is (somewhat remarkably) making its first ever acquisition, buying comic book company Millarworld, which was started by Mark Millar and some former colleagues who had all written comic books for DC and Marvel and wanted a bigger stake in their creations, nearly 15 years ago. The terms of the deal aren’t being disclosed, so it’s far from clear what the immediate financial impact on Netflix will be, either in terms of the acquisition price or the revenue or profits from adding this first bit of diversification to the business. The whole announcement from Netflix reads like a subtle dig at Marvel, which is interesting given the close relationship the two companies currently enjoy. Millar is described as a “modern-day Stan Lee”, when of course Stan Lee himself is still alive and actively involved in the community if not actively creating new content, while the release also says that Millar was behind a number of the characters whose stories have been turned into movies by Marvel Studios over the last few years. Clearly, the claim here – somewhat farfetched – is that Millarworld is the new Marvel. Several of its characters and stories have already been turned into movies in recent years, and with some success, so it’s not a totally absurd claim. But overall few of them have the mass-market name recognition of Marvel or DC’s characters, and some quick feedback from people on Twitter who are more into this world than I am suggest that as a competitor it’s a pretty distant third behind the big two. This is clearly an attempt to secure more original content for Netflix, but also something of a hedge against the time that Netflix’s deal with Disney and therefore Marvel goes away, though on the latter point the acquisition also likely raises the risk that deal does go away, so perhaps Netflix has already had signals (or has simply decided independently) that it won’t renew. But it doesn’t sound like it’s going to provide anything like the same quality or quantity of content for Netflix that the Marvel deal does.
via Netflix (PDF)
This may help explain why Netflix laid out its content economics in even more detail than usual in last week’s earnings material: it’s apparently taking out a further $500 million line of credit, with an option to extend that by an additional $250 million. The driver is clearly its rapidly growing investment in original content, which has to be paid for up front, in contrast to the existing content it licenses, which is paid for as it’s made available on the site. All of that means that shifting to original content pushes cash burn much earlier in the process and thereby dramatically increases Netflix’s negative free cash flow, something I explained in some detail in this Variety piece last month. As I’ve said before, there’s no real reason why this should be a concern for investors, as long as Netflix is able to keep up its rapid pace of revenue growth, which is currently more than enough to fund its content investments and justify its increased borrowing. But the company’s debt load continues to rise fairly rapidly and at some point it will need to ease off and see that free cash flow picture change to something more positive.
Netflix today kicked off the Q2 earnings season with the first official earnings from a company that I cover, and reported stronger than expected subscriber growth off the back of a House of Cards season launch that was pushed back from Q1. Netflix was way off on its sub growth forecast, and though it surprised on the upside this time around that hasn’t always been the case in several recent guidance misses. Even though Netflix didn’t mention it this quarter, the delayed HoC launch screwed around with lots of year on year comparisons both this quarter and last, since Q1 is usually by far its strongest quarter for subscriber adds and Q2 is usually the low point of the year. Taking a step back, though, Netflix continues on its recent tear, with international growth the major driver, and profits domestically continuing to grow nicely off the back of last year’s price increases. Importantly, Netflix is now projecting that the international business will be profitable on a contribution basis for 2017 as a whole, which will be another major milestone after total non-US subs surpassed US streaming subs for the first time in Q2. The cash flow drain continues to be rapid, with an average of over half a billion dollars per quarter in negative free cash flow over the past year, and over $2 billion in cash content costs in Q2, and $8 billion over the past year, relative to the $6 billion Netflix protected for 2017 on a P&L basis (see this Variety piece I wrote last month for why cash and P&L spending are so different). For now, the subscriber and associated revenue growth are keeping Netflix out ahead of its content spending, but Netflix absolutely has to continue to grow at close to the current rate if it’s to continue to finance massive original content costs and grow profits at the same time.
This is a good time to remind you about the Jackdaw Research Quarterly Decks Service I also offer, which provides slide decks and videos on roughly a dozen major tech companies including Netflix each quarter during earnings season. Tech Narratives subscribers get a 50% discount, so let me know if you’re interested and I’ll send you a coupon code. The Q2 Netflix deck is available now, and will be updated in a few days when the 10-Q is out with more data. You’ll find some of the charts in this Twitter thread from earlier.