Netflix Is Smart to Bet the House on Content
(Bloomberg View) -- I had planned to write a little ode to Netflix Inc. some time ago, a meditation on the 20th anniversary of its founding. But I got waylaid, and I'm glad I did, because two months later we’re in the middle of one of those classic Netflixian moments, when both the exhilarating promise and the extraordinary peril of its business strategy comes into stark relief.
It began last week when Netflix announced its third-quarter earnings. They showed -- hooray! -- a big jump in both subscribers and revenue. The numbers also revealed -- uh-oh! -- over $450 million in negative cash flow, minuscule earnings and pitiful margins. Plus Netflix announced it would raise its already huge content spending to as much as $8 billion next year from the current $6 billion. That's right: $8 billion. As my Bloomberg Gadfly colleagues Lisa Abramowicz and Shira Ovide pointed out recently, Netflix's costs for acquiring and producing content have doubled in two years and are growing faster than its revenue.
The only way Netflix can pay for this all this content is by borrowing lots of money. Thus on Monday, the company revealed that it would soon issue $1.6 billion in bonds. Bloomberg Intelligence analyst Stephen Flynn expects the company to borrow a further $1.4 billion within the next year. Since 2012, Netflix's debt has risen from $200 million to nearly $5 billion, a number that will surely continue to rise. Morgan Stanley estimates that Netflix won't have positive cash flow until 2021 -- if then.
What these numbers illustrate is that Netflix is walking a high wire. As Abramowicz and Ovide point out, "the company's entire business model relies on a very compliant debt market." What happens to Netflix if the bond market becomes less forgiving?
There are lots of other questions too: What happens if subscriber growth flattens and revenue falls further behind its costs? Or if it produces a series of duds, and the buzz about Netflix shows fades? Or if Amazon, which has 15 times Netflix's revenue, starts producing hit shows that its Prime customers can watch for free? Or if Netflix makes a big strategic mistake, as it did in 2011 when it tried to separate its streaming business from its DVD business? Netflix’s high-wire finances mean that far more than most companies, it can't afford a slipup.
But why? Why is Netflix so willing to run up debt to produce more content -- 80 movies in 2018! -- than any company ever has? Why, with all its current success, does Netflix seem to be in a “bet the company” mode?
The answer is that Netflix is trying to outrace the future -- and this is the moment when that future is going to be decided. Less debt and lower costs would mean higher profits in the here and now. But it would greatly diminish Netflix’s chances of becoming a truly global network and the dominant content company of the 21st century. For Netflix, that goal justifies an awful lot of risk.
Streaming, of course, isn’t just the future. It’s already here. And it’s not just Netflix, Amazon.com Inc. and Hulu LLC, either. YouTube has lots of television-style content. You can now stream HBO without having to subscribe to cable television. Ditto for CBS’s programming. The networks like FX and AMC that have helped usher in this golden age of scripted dramas have made their programming available online. The Walt Disney Co. has announced that it is will pull content off Netflix, and put it on its own planned streaming service.
It is hard to know how this will all play out, and who the winners will be. Amazon, for instance, is spending $4.5 billion on its Prime content this year without much to show for it. But chief executive Jeff Bezos had made it clear that he wants Amazon’s programmers to buy buzzier shows to better compete with Netflix. One suspects Amazon will ultimately be a formidable streaming presence.
Apple Inc. is said to be considering getting into content. Ditto LinkedIn Corp. HBO has the best content around, but will it ultimately remain a stand-alone streaming service, or will it be folded into a larger Time Warner Inc. service that might also include Warner Bros. cartoons, classic shows like “F Troop” and Turner Broadcasting’s sports content? Who can say?
When this all shakes out over the next five to 10 years, there will likely be, at most, a half-dozen dominant players. Though there will also be plenty of niche streaming services, most people are not going to be willing to pay monthly fees for more than a handful of content companies. The companies with the broadest array of content and with a constant infusion of new content will be the winners. Netflix wants to be the company that you view as your core network -- the one you will always pay for, even if you are cutting back on other services.
Is it any wonder, then, that Netflix is breaking the bank to produce movies and TV shows? Every one of its competitors has more resources than it has. Every one wants to be among the half-dozen winners. And every one, resentful of the brand Netflix has created, is looking for ways to cut the company down to size. That’s why Netflix has been transitioning from a company that licenses content from other companies to one that produces its own shows. Doing so is very expensive.
For all the risks inherent in Netflix’s strategy, it has so far been remarkably successful. Its revenue has doubled in three years, and its subscribers have nearly doubled in two. Netflix has also transitioned from a U.S.-centric company to one that streams shows and movies everywhere in the world except China, Syria, North Korea and Crimea. Although critics complain that its content is often subpar, its customers are hooked, typically watching 30 to 40 hours a week. For millions of people, Netflix has become television. You can’t say that about any other streaming service.
So yes, as much as it may seem that Netflix is taking oversized risks, it strikes me that these are risks well worth taking. And given the company’s track record, I’m guessing those risks will pay off. Someday we’re going to look up and realize that Netflix has become the Facebook or Google of online media.
Netflix's critics should chill.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Joe Nocera is a Bloomberg View columnist. He has written business columns for Esquire, GQ and the New York Times, and is the former editorial director of Fortune. He is the co-author of "Indentured: The Inside Story of the Rebellion Against the NCAA."
By comparison HBO is spending around billion on content this year, and even mighty Amazon is under billion.
Many of the top content executives believe that they unwittingly handed the keys to the kingdom to Netflix by licensing their content to it. Some of them, like David Zaslav, the chief executive of Discover Communications, are on record saying they wish they’d never done so, even though the licensing revenue they got from Netflix was pure profit.
The latter three are because of U.S. restrictions on business.
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