NFLX - Netflix

[loganc]

I appreciate that everyone wants to talk about the strides that NFLX has made with respect to exclusive content.  The company has done a great job in that regard over the last few years.  However, HBO continues to deliver on that front and Amazon has obviously made strides to that end as well.

 

I have a few comments for NFLX bulls:

 

(1) Contribution Margin from Growth

 

I think the math that has been thrown around in this thread is highly suspect.  I think it is fairly clear that the contribution margin from incremental subscriber dollars will not be 100%.  First, the International streaming business is sub-scale and incremental international subscriber revenues (i.e. the high growth engine) are not flowing directly to the bottom line.  Second, management is guiding for a contribution margin target of 40% for the Domestic streaming business in 2020.  Even in the Domestic business with scale, the assumption of incremental subscriber revenue [1] flowing directly to the bottom line would imply well north of 50% contribution margins.  I think the back of the envelope math is hard to justify here.   

 

(2) Content Liabilities & Capital Requirements

 

As of 3Q15, 90% of 10.4B of total content liabilities are due within three years.  I believe this necessarily means that NFLX is going to be renegotiating these costs within that time frame.  What sort of terms will NFLX be able to negotiate?  I think this is a very tough question. 

 

Further, given the lack of scale in the International business and the fact that the major growth driver is in the International geographies, I believe that NFLX is going to need to raise significant capital to achieve the growth that is implicit in the stock price.  To this point, it seems to me that the profitable DVD business has more or less offset the losses from the International streaming business.  The DVD business seems to be in decline and the International streaming business is the primary growth engine.  It seems like this dynamic is going to break soon and, while the margin from the Domestic streaming business should expand, I think the NFLX shareholder has to assume that quite a lot of additional capital must be raised.

 

Management appears to be guiding for a capital raise in late 2016 or early 2017 and it would appear that they expect to do a debt financing.  Perhaps they will be able to pull off a debt financing at that time.  Obviously, it is hard to prognosticate the state of the credit markets.  However, I find it very interesting that management states their intent to lower the "blended cost of capital over time, while maintaining financial flexibility."  It seems to me that achieving that objective would necessarily include issuing NFLX common stock.  At present, a convertible security or common stock issuance seems like the best way to achieve that objective.   

 

(3) Competitive Advantage

 

When I think about NFLX from a very high level, I struggle to understand the competitive advantage of this business.  I don't believe that streaming technology is a competitive advantage as it is ubiquitous.  I would acknowledge that the "discovery" aspect of NFLX is very good and that they have done a great job of "curating" content.  In terms of the proprietary content, I am not sure how much anyone is going to care about House of Cards in five years.  I am not sure what kind of terminal multiple one would put on NFLX if the end game is to turn it into a de facto movie studio.

 

[1] I am assuming growth to 64MM subs and $10 ARPU in 2020.

[frommi]

I have a very hard time seeing NFLX earning $8 billion in 2020.  HBO earns $1.8 billion pre-tax today and already has roughly 2x as many subscribers worldwide, charges 2x as much per month, has a much better library of exclusive content, and has a huge chunk of new releases tied up for a while allowing it to actually have good movies. 

 

Essentially all the content in the U.S. is owned by six companies.  Do you really think those six companies are going to sit and watch NFLX make $8 billion a year distributing their content?  They'll all have their own apps very soon and then there will be a free or dirt cheap aggregator (probably Apple) that bundles it all together in one NFLX like user interface.

 

I agree that having the content is important, but Disney and HBO have their apps already in place since some time and still don`t have that much subscribers. So it looks like having the biggest distribution network, the cheapest price and the best user experience may be valuable. HBO has a lot of their subscribers via the traditional cable channels, where you don`t know if that customer is just paying for it because its in the cable bundle. When these customers cut the cord, they won`t install an HBO now app, especially at current prices. I for example had it in my Sky Germany package, but never watched any of their series.

 

Netflix on the other hand is already the biggest spender on content (>50% of revenue), and i doubt that HBO will grow meaningful in the future. For Netflix, more subscribers = more revenue = more content = more subscribers will be true for some time in the future, while HBO`s moat will shrink and with it its revenues.

When you are in a competive bidding process and your competitors get weaker, than prices for content will go down. I know that is not what a lot of people on CoBF want to hear, but i think that is what will happen.

[LC]

I'm torn on Netflix.

 

On one hand I think they create good internal content. The flipside is that they create good internal content now. Successful content creation can be a difficult task to replicate over time and I don't see anything special about Netflix which causes me to believe they will be able to replicate this feat.

 

I agree they should be able to grow the subscriber base.

 

On the other hand I believe their acquired content will fall in quality as more and more content creators wise up. IMHO their library is not as impressive as it was a few years ago. They have had to make choices based on rising content prices from studios.

 

I'd rather own a quality content producer (Disney for example) than the company distributing the content, especially when I'm not convinced on the staying power of that distributor.

[cmlber]

I have a very hard time seeing NFLX earning $8 billion in 2020.  HBO earns $1.8 billion pre-tax today and already has roughly 2x as many subscribers worldwide, charges 2x as much per month, has a much better library of exclusive content, and has a huge chunk of new releases tied up for a while allowing it to actually have good movies. 

 

Essentially all the content in the U.S. is owned by six companies.  Do you really think those six companies are going to sit and watch NFLX make $8 billion a year distributing their content?  They'll all have their own apps very soon and then there will be a free or dirt cheap aggregator (probably Apple) that bundles it all together in one NFLX like user interface.

 

I agree that having the content is important, but Disney and HBO have their apps already in place since some time and still don`t have that much subscribers. So it looks like having the biggest distribution network, the cheapest price and the best user experience may be valuable. HBO has a lot of their subscribers via the traditional cable channels, where you don`t know if that customer is just paying for it because its in the cable bundle. When these customers cut the cord, they won`t install an HBO now app, especially at current prices. I for example had it in my Sky Germany package, but never watched any of their series.

 

Netflix on the other hand is already the biggest spender on content (>50% of revenue), and i doubt that HBO will grow meaningful in the future. For Netflix, more subscribers = more revenue = more content = more subscribers will be true for some time in the future, while HBO`s moat will shrink and with it its revenues.

When you are in a competive bidding process and your competitors get weaker, than prices for content will go down. I know that is not what a lot of people on CoBF want to hear, but i think that is what will happen.

 

Frommi, I think investors have been conditioned to believe in the " more subscribers = more revenue = more content = more subscribers " flywheel by the experience of the cable industry.  But there is a major difference here.

 

In cable, scale means you have more negotiating leverage and can therefore get content cheaper on a per user basis.  There historically have really only been a couple buyers of content in a given geographic area: the local cable company and satellite companies.  Now you have the local cable company, Dish, Directv, Nflx, Amzn, soon Apple, telcos, or you can very easily go direct to the customer through Apple TV or internet connected TVs.

 

As a result, content owners have all the leverage.  Every time NFLX grows subscriber count, the content costs will just rise proportionally. 

 

I think it's a mistake to call this a competitive bidding situation, most of these content deals are not exclusive.  Having more subscribers means you can pay more than someone with fewer subscribers, but Disney can (and will) just sell to both companies and charge based on number of subscribers or viewing hours. 

 

If there is $120 billion of value to go after, and the capital costs are basically $0 and there are no barriers to entry whatsoever and no switching costs (I can turn NFLX subscription on and off in 2 minutes), why won't competition eat away at margins?

[frommi]

I'd rather own a quality content producer (Disney for example) than the company distributing the content, especially when I'm not convinced on the staying power of that distributor.

 

I understand that, but i think that is like playing the game like the ball is standing still and not going where the ball will be 10 years out. Content at the moment is valuable because there are a lot of distributors out there bidding for it. In the long run the subpar distribution channels will disappear because they can`t keep up with the big guys. For me in the endgame there will only be one or two players, and outside of Netflix and Amazon i see nobody that is willing to give up short term profits for long term success. How valuable is an internet TV distribution monopoly/oligopoly?

 

Of course i can be wrong on a lot of points and thats the reason i secured the position with a put. For me personally since i missed buying Apple stock in 07/08 despite being one of the first iPhone users i am really looking hard at what things i use and if i can profit from that insight. I think i would really regret not buying the stock if it doubles from here, especially since the chart looks set up for an hyperbolic run. But who knows, if this turns out to be a mistake i hopefully learn a lesson or two.

[cmlber]

I'd rather own a quality content producer (Disney for example) than the company distributing the content, especially when I'm not convinced on the staying power of that distributor.

 

I understand that, but i think that is like playing the game like the ball is standing still and not going where the ball will be 10 years out. Content at the moment is valuable because there are a lot of distributors out there bidding for it. In the long run the subpar distribution channels will disappear because they can`t keep up with the big guys. For me in the endgame there will only be one or two players, and outside of Netflix and Amazon i see nobody that is willing to give up short term profits for long term success. How valuable is an internet TV distribution monopoly/oligopoly?

 

Of course i can be wrong on a lot of points and thats the reason i secured the position with a put. For me personally since i missed buying Apple stock in 07/08 despite being one of the first iPhone users i am really looking hard at what things i use and if i can profit from that insight. I think i would really regret not buying the stock if it doubles from here, especially since the chart looks set up for an hyperbolic run. But who knows, if this turns out to be a mistake i hopefully learn a lesson or two.

 

I think you've got this totally backwards.  The # of distributors will rise dramatically over time.  Distributing content over the Internet has virtually no fixed costs and there is no customer switching cost.  I think it's a big mistake to think of content as fixed.

 

If NFLX wasn't doing original content and was a pure distributor, it would be a gigantic short.  The only potential saving grace, and reason I'm not short, is the original content.  If they can hook their user base to long life TV shows, switching costs will rise and they can potentially raise price. 

[rmitz]

That sounds right. Maybe it's just semantics, but the current dialog around NFLX seems to imply that they're some sort of content creation juggernaut.

 

It’s more about the fact they can fund content creation because it’s more useful and has more utility in their targeted viewing envrionment.  It also allows them to capture more of the value chain.

[dwy000]

The other player who may be taking long term steps to get it right is YouTube.  They are working with content partners to allow them to develop their own channels which allows them to maintain the brand (so you aren't just watching Mad Men, you are watching AMC) and also manage the advertising content.  YouTube doesn't have to pay for content, they get a share of the revenues. 

 

I struggle to believe there will be 10-15 OTT providers each with 1-2 proprietary channels and each with separate subscriber bases getting monthly bills.  Content will be aggregated because it is easier for consumers and provides access to bulk for providers.  Right now the cablecos do that over cable and are probably the best positioned to do it over internet - but obviously that cannibalizes current revenues.

 

The other factor you can't ignore with OTT and cord cutting is the cost of naked broadband.  It's not cheap if you want a decent connection to watch HD video and certainly a large premium to packaged broadband (with cable).  If cablecos switch to a metered or capped system that makes internet based streaming more expensive, it will throw the whole business model into disarray.

[jschembs]

I struggle to believe there will be 10-15 OTT providers each with 1-2 proprietary channels and each with separate subscriber bases getting monthly bills.  Content will be aggregated because it is easier for consumers and provides access to bulk for providers.  Right now the cablecos do that over cable and are probably the best positioned to do it over internet - but obviously that cannibalizes current revenues.

 

Recent John Malone investment - http://www.uxpsystems.com/ - opportunity to integrate disparate OTT platforms for billing/customer service purposes. This could make it much easier for more fractured OTT offerings, which I think is a significant risk to the aggregators.

[frommi]

Thanks for all the feedback, in the end my conviction was not strong enough to hold the position. Had a sleepless night and seeing Hasting sell big blocks of stock hasn`t helped either. I think valuation is really a bit stretched here and my napkin math was a bit to easy.

[TwoCitiesCapital]

Thanks for all the feedback, in the end my conviction was not strong enough to hold the position. Had a sleepless night and seeing Hasting sell big blocks of stock hasn`t helped either. I think valuation is really a bit stretched here and my napkin math was a bit to easy.

 

Congrats!

 

I'm thinking about re-opening my short now that it's company specific woes dragging it down and not general market sentiment. Each $1 the stock price drops is a double-whammy because it increases the number of shares they have to issue to keep the company afloat to continue to afford their current cash burn/content acquisition.

 

If we're getting genuine concerns about the future growth of the company, methinks we'll see significantly lower lows as people try to front-run the multi-billion dollar issuances that will dilute them massively given that raising more debt isn't really an option.

[Vish_ram]

Last week I cancelled my NFLX membership. I get quite a few shows and movies to watch in Amazon prime. The content in prime has absolutely exploded.

 

I do occasionally order movies in iTunes.

[muscleman]

I have a very hard time seeing NFLX earning $8 billion in 2020.  HBO earns $1.8 billion pre-tax today and already has roughly 2x as many subscribers worldwide, charges 2x as much per month, has a much better library of exclusive content, and has a huge chunk of new releases tied up for a while allowing it to actually have good movies. 

 

Essentially all the content in the U.S. is owned by six companies.  Do you really think those six companies are going to sit and watch NFLX make $8 billion a year distributing their content?  They'll all have their own apps very soon and then there will be a free or dirt cheap aggregator (probably Apple) that bundles it all together in one NFLX like user interface.

 

I agree that having the content is important, but Disney and HBO have their apps already in place since some time and still don`t have that much subscribers. So it looks like having the biggest distribution network, the cheapest price and the best user experience may be valuable. HBO has a lot of their subscribers via the traditional cable channels, where you don`t know if that customer is just paying for it because its in the cable bundle. When these customers cut the cord, they won`t install an HBO now app, especially at current prices. I for example had it in my Sky Germany package, but never watched any of their series.

 

Netflix on the other hand is already the biggest spender on content (>50% of revenue), and i doubt that HBO will grow meaningful in the future. For Netflix, more subscribers = more revenue = more content = more subscribers will be true for some time in the future, while HBO`s moat will shrink and with it its revenues.

When you are in a competive bidding process and your competitors get weaker, than prices for content will go down. I know that is not what a lot of people on CoBF want to hear, but i think that is what will happen.

 

Frommi, I think investors have been conditioned to believe in the " more subscribers = more revenue = more content = more subscribers " flywheel by the experience of the cable industry.  But there is a major difference here.

 

In cable, scale means you have more negotiating leverage and can therefore get content cheaper on a per user basis.  There historically have really only been a couple buyers of content in a given geographic area: the local cable company and satellite companies.  Now you have the local cable company, Dish, Directv, Nflx, Amzn, soon Apple, telcos, or you can very easily go direct to the customer through Apple TV or internet connected TVs.

 

As a result, content owners have all the leverage.  Every time NFLX grows subscriber count, the content costs will just rise proportionally. 

 

I think it's a mistake to call this a competitive bidding situation, most of these content deals are not exclusive.  Having more subscribers means you can pay more than someone with fewer subscribers, but Disney can (and will) just sell to both companies and charge based on number of subscribers or viewing hours. 

 

If there is $120 billion of value to go after, and the capital costs are basically $0 and there are no barriers to entry whatsoever and no switching costs (I can turn NFLX subscription on and off in 2 minutes), why won't competition eat away at margins?

 

I agree with you. The difference is that cable cos are local monopolies, but NFLX is not. I expect the number of OTTs to mushroom quickly in the future. It is just so easy to create one.

However, if NFLX succeeds in creating a lot of their own long shelf life content, then the story would change, as they evolve into a content maker. But how likely is it that they are a better content maker than the existing ones? The content makers seem to have a first mover advantage.

[cmlber]

I have a very hard time seeing NFLX earning $8 billion in 2020.  HBO earns $1.8 billion pre-tax today and already has roughly 2x as many subscribers worldwide, charges 2x as much per month, has a much better library of exclusive content, and has a huge chunk of new releases tied up for a while allowing it to actually have good movies. 

 

Essentially all the content in the U.S. is owned by six companies.  Do you really think those six companies are going to sit and watch NFLX make $8 billion a year distributing their content?  They'll all have their own apps very soon and then there will be a free or dirt cheap aggregator (probably Apple) that bundles it all together in one NFLX like user interface.

 

I agree that having the content is important, but Disney and HBO have their apps already in place since some time and still don`t have that much subscribers. So it looks like having the biggest distribution network, the cheapest price and the best user experience may be valuable. HBO has a lot of their subscribers via the traditional cable channels, where you don`t know if that customer is just paying for it because its in the cable bundle. When these customers cut the cord, they won`t install an HBO now app, especially at current prices. I for example had it in my Sky Germany package, but never watched any of their series.

 

Netflix on the other hand is already the biggest spender on content (>50% of revenue), and i doubt that HBO will grow meaningful in the future. For Netflix, more subscribers = more revenue = more content = more subscribers will be true for some time in the future, while HBO`s moat will shrink and with it its revenues.

When you are in a competive bidding process and your competitors get weaker, than prices for content will go down. I know that is not what a lot of people on CoBF want to hear, but i think that is what will happen.

 

Frommi, I think investors have been conditioned to believe in the " more subscribers = more revenue = more content = more subscribers " flywheel by the experience of the cable industry.  But there is a major difference here.

 

In cable, scale means you have more negotiating leverage and can therefore get content cheaper on a per user basis.  There historically have really only been a couple buyers of content in a given geographic area: the local cable company and satellite companies.  Now you have the local cable company, Dish, Directv, Nflx, Amzn, soon Apple, telcos, or you can very easily go direct to the customer through Apple TV or internet connected TVs.

 

As a result, content owners have all the leverage.  Every time NFLX grows subscriber count, the content costs will just rise proportionally. 

 

I think it's a mistake to call this a competitive bidding situation, most of these content deals are not exclusive.  Having more subscribers means you can pay more than someone with fewer subscribers, but Disney can (and will) just sell to both companies and charge based on number of subscribers or viewing hours. 

 

If there is $120 billion of value to go after, and the capital costs are basically $0 and there are no barriers to entry whatsoever and no switching costs (I can turn NFLX subscription on and off in 2 minutes), why won't competition eat away at margins?

 

I agree with you. The difference is that cable cos are local monopolies, but NFLX is not. I expect the number of OTTs to mushroom quickly in the future. It is just so easy to create one.

However, if NFLX succeeds in creating a lot of their own long shelf life content, then the story would change, as they evolve into a content maker. But how likely is it that they are a better content maker than the existing ones? The content makers seem to have a first mover advantage.

 

Also, you hear a lot about their "scale advantage" in producing content.  That's simply not true.  If anything it's a disadvantage.  Any third party making content has the ability to sell it to Netflix AND whoever else wants to buy it.  If Netflix is making exclusive content then it services a much smaller population than third party content studios.

 

That's not to say they couldn't get lucky with some hit content that makes it worth this valuation, but then you're essentially buying into a start up content studio which historically has been an average return on capital business at best. Paying 18x book value for a business with average returns on capital doesn't sound that exciting.

[Spekulatius]

Last week I cancelled my NFLX membership. I get quite a few shows and movies to watch in Amazon prime. The content in prime has absolutely exploded.

 

I do occasionally order movies in iTunes.

 

We cancelled our NFLX membership as well, for the same reason. We had it for 6 years or so, but also have prime and I found that more than 80% of what we watch in Netflix, is covered by Amazon Prime.

[SlowAppreciation]

Bought a bigger position in NFLX today. I really like the content they create and their global expansion is just starting. Based on my napkin math they should be able to double the subscriber base in 3-4 years and every additional customer $ goes directly to the bottom line. Even if you believe that they don`t generate profits today, (which i don`t) that means 8 billion $ earnings in 2020. Put a conservative multiple of 15x on it and we are at a 120 billion marketcap company in 4 years. Thats nearly a triple from here. Any flaws in my thinking?

 

(I've just started looking at Netflix so take everything with a grain of salt)

 

I don't find any flaws with it really, but premium content costs are around $7b annually, whereas HBO is 1/3rd of that with 2x the subscriber base.

While you mentioned any subscriber growth goes straight to the bottom line as content costs are spread across a greater # of users, what makes this business any better than HBO? In fact, HBO's distribution costs are lower since they license some of their content.

 

Lastly, while Netflix's content is great, I still don't think it's quite on par with HBO.

[Jurgis]

Lastly, while Netflix's content is great, I still don't think it's quite on par with HBO.

 

There's a lot of crap Netflix content IMO. (Don't rely on my taste though... actually if you asked me, I don't remember a single good Netflix show. But there's more than one that are crap even based on Netflix show fans.)

 

IMO Netflix/Amazon are fueling content bubble. There was too much content before they joined the fray. Now it's getting way too much. I guess content is still quite profitable, since we've seen pretty zero contraction in the business so far (apart from STRZA purchase by LGF which may not have reduced content much). But I wonder.

[rkbabang]

Last week I cancelled my NFLX membership. I get quite a few shows and movies to watch in Amazon prime. The content in prime has absolutely exploded.

 

I do occasionally order movies in iTunes.

 

 

We cancelled our NFLX membership as well, for the same reason. We had it for 6 years or so, but also have prime and I found that more than 80% of what we watch in Netflix, is covered by Amazon Prime.

 

 

That surprises me.  My kids watch youTube more than anything, but my wife and I watch probably 80% Netflix, 15% cable/HBO/Showtime, and 5% Amazon Prime.  Amazon's originals are good and getting better, but besides that we can rarely find anything to watch on Amazon.  I don't know if it is that the app is so bad and difficult to search and they don't recommend shows as well as Netflix or what?  That goes for everything except their originals which are all in one place and easy to find.  We will sit down and open the Amazon app, search for a while then go to Netflix and find something to watch almost immediately.  If it wasn't for the Amazon originals we wouldn't watch Amazon prime at all.  We are members for the shipping and the cloud storage, not for the streaming.

 

 

 

 

[Kapitalust]

Netflix has a lot of shit content with some gems sprinkled in. Over the years, I've noticed I was spending more time browsing around looking for something actually good to watch rather than watching anything at all.

 

They also make some good original content, however, most of the original content is fairly mediocre.

 

We've shifted in recent years to cancelling our Netflix subscription and then just turning it back on every now and then if there is a show/movie that we want to watch, then just turning off the auto-renew so that it cancels in 1 month.

[fareastwarriors]

I just watch old stuff on Netflix. I don't want to watch something with just one season available and then I have to wait for one year before the next season is released.

 

You guys should just share accounts. My current plan allows for 2 streams. They are constantly being used. I share among like 5/6 people. No one is on Prime Video even though that is being shared too.

[TwoCitiesCapital]

Netflix has a lot of shit content with some gems sprinkled in. Over the years, I've noticed I was spending more time browsing around looking for something actually good to watch rather than watching anything at all.

 

They also make some good original content, however, most of the original content is fairly mediocre.

 

We've shifted in recent years to cancelling our Netflix subscription and then just turning it back on every now and then if there is a show/movie that we want to watch, then just turning off the auto-renew so that it cancels in 1 month.

 

This is what I've started doing. I cycle through the subscriptions based on when things are being released. Have been subscribed to NFLX the last 2-3 months to watch Shameless and some other shows that I was missing the new seasons of and will cancel and re-subscribe to HBO when Game of Thrones comes back on.

 

HBOs content is more limited, but of exponentially greater quality.

 

[LC]

Netflix has realized that "killer content" is where its at, which is why they are producing their own now.

 

HBO sells the majority of its subs based on 1 show.

 

Distribution is the commodity.

Content is the value add

[bonkers]

As many others have highlighted, also to me Netflix does not seem to have clear strong advantages. However, there is something on the soft side from just having scale, which are

1) huge visibility and share of mind with global audience

2) being pre-installed on many devices and thus easy to use

 

The average consumer isn't very tech-savvy or monitoring every penny (unlike maybe most people here). They look for easy solutions, and it's much easier to choose Netflix and keep it vs. to shop around all the time among unknown providers. Even if this advantage is not durable, for the time being it's real.

 

What comes to content I do presume that Netflix should have some scale just from the huge bargaining power they start to have (do you want access to Netflix audience or not?), although it is smaller than in cable as deals technology-wise probably even cannot be geographically exclusive.

 

I'm speculating if Netflix might use user data from its large audience to produce better content, like series that addict their watchers better. This might give it an advantage the old players have not traditionally had (but that they could soon acquire as well), helping to produce higher ROI content.

 

Otherwise I think content production is risky business, and I wouldn't want to be in it. I remember John Malonen saying something like he has made the mistake of entering content production three times, always with the same (bad) result.

[rogermunibond]

Does this give Amazon Prime Video an advantage?  Granted they are also paying for free shipping.  There's likely to be less churn since it's sold on an annual subscription.  Didn't realize people were churning HBO Go, Netflix, Hulu, etc.

[DooDiligence]

Does this give Amazon Prime Video an advantage?  Granted they are also paying for free shipping.  There's likely to be less churn since it's sold on an annual subscription.  Didn't realize people were churning HBO Go, Netflix, Hulu, etc.

 

Consumers are learning they can opt out as content gets stale & opt in again when it freshens.

 

Amazon seems to have the best value add & I think you can go month to month now in addition to the annual membership.

 

Maybe WalMart will buy Netflix  :P