It seems an interesting phenomenon has arisen in the world of financial analysis and industry evaluation, especially in streaming media. Are we observing an era of analysts transferring current Instagram-instant gratification values into their business analysis, or are the value of long-range planning and investment in building a business no longer recognised or worthy of evaluation?
Netflix provided its Q2 2021 financial reporting last week. After a bunch of quarter-on-quarter comparative number crunching, the response from analysts and industry observers was generally one best categorised as ‘not good enough’. A minor market correction, likely a slight portfolio adjustment and profit-taking more than tanking, was the consistent response from investors in the week that followed. Their response was consistent with five out of the last seven quarterly reports.
Most exchange-traded companies would have investors beating a path to their door, applauding the kind of performance Netflix reported from a business with global operations. But it seems like many analysts, industry observers have taken a rather myopic view of the Netflix business, focussing on subscriber numbers, a lower EPS and what they perceive as an annoying dedication to their core business.
Many seem fascinated by the company’s insistence to abstain from offering an AVOD of FAST version of the service, suggesting the company should move immediately to ‘rent out’ their expensive catalogue of original content to the highest commercial spot-buying bidder.
Quarterly statistics are a handy pulse check, but the lust for ever-increasing short term gains, are often focus-draining and result in the diversion of resources at the expense of long term strategy. Such thinking has given rise to the new exchange LTSE (Long Term Stock Exchange), which I wrote about previously in an earlier blog.
This approach is ignoring investment in other significant customer-centric business factors. By comparison, in big infrastructure projects, analysts can measure and quantify concrete, steel and labour. In entertainment, the future belongs to those who have built share of mind, emotional connection, loyalty, and the elusive satisfaction of customer experience.
Netflix Prior Performance Set Lofty Expectations
Number crunching analysts have predominantly focussed their review of the Q2 2021 report on the mixed results of short-term indicators, conferring little value and demonstrating little knowledge of the long-term end game that Netflix is already vested in.
At time of writing NFLX share price was US$516, they have Net Debt of $7.85 Billion ($17.71 per share or 2.9%) = Cash & Cash Equivalents – Total Debt (excl. convert), Cash & Cash Equivalents = $7.78 Billion. Total Debt (excl. convert) = $15.63 Billion Source: Netflix 10-Q (quarterly report)
With in excess of $8 billion in cash reserve, an untouched $750 million line of credit, monthly revenue over $7 billion, and a growing asset of international content catalogue, you can somewhat comfortably sustain a debt of US$15+ billion.
In Q2 2021 Netflix lost 430,000 subscribers in the mature, highly competitive UCAN market. Still, they had an eight percent growth in average revenue per membership, and their UCAN ARPU at $14.54 is higher than any other streamer in the region. That says Netflix might have many competitors, but their subscribers find fair value in their service.
The Hollywood Reporter said: “The streaming giant has had a rough 2021 so far in terms of subscriber growth. In Q1 it added only 4 [sic] million subscribers”
The addition of over 1.5 million new international subscribers (one million from the Asia-Pacific region) was 500,000 or 50% above projections.
The addition of four million new subscribers in Q1 and 1.5 million new subs in Q2 brings Netflix global streaming paid memberships to a total of 209 million, delivering QUARTERLY revenue of US$7.16 billion in Q1 and US$7.3 billion in Q2. I’d suggest that’s a “rough year” of dreams for many a business!
The Observer said: The “pull forward” effect of the pandemic has left the company in a state of malaise this year.
The comment above arose for having lower earnings per share of $2.97 versus the estimate of $3.16. Netflix lost further share in Q2 global platform demand of all digital originals, slipping to 48.3% from 50.1% in Q1 2021 (down from 54.9% in Q2 2020).
The contraction in viewing time is likely a reflection of competitive forces as viewers try the bundles and content packages of competitor streamers. There was also a kind of enforced hiatus on new content releases, the result of Covid on production activity. Ironically Covid may once again deliver a bonus to Netflix as they have a backlog of content they can now release in concentrate in measured form to new and dedicated audiences.
The modest total return of 0.06% on the Netflix share price over the past year is, to my mind, more of a reflection of the business performance in the maturing market in the home UCAN market. The market is saturated. More than 80% of American consumers have at least one streaming service subscription, and the average subscriber pays for four different streaming services. Some of which are on test drive.
The big question is which of those services will be retained and why? That’s the position Netflix is investing in from a global perspective.
Netflix Plays The Long Game
Industry commentary keeps banging on about how Netflix has to keep some monstrous level of original content production up, and it does to some extent. It’s not lost on me that so much of Netflix competitor’s content catalogues are back catalogue, including Disney+, Paramount+, HBO max etc. each of which have extensive catalogues, but they are predominantly – let’s call it ‘aged’ content. I think analysts observe the large content catalogues some streamers have access to or own, but have not recognised that the value of a lot of this content is declining with age. The value is diluted with every time the content is viewed and a lot of these content libraries have been viewed from theatre to FTA and all screens in between for years, in some cases decades.
Some of the most recognisable titles and talent are unknown to the emerging viewer market. A recent survey of teenagers leaving a course at AFTRS revealed our most revered screen directors ie. Philip Noyce, Bruce Beresford, and Jane Campion were unknown, even Baz Lurhman was barely recognised. The emerging-market does not seek out this old content, they watch more original content on YouTube, Netflix and niche interest channels. These libraries represent most value to the large demographic of over 55’s who represent the greatest potential for new subscriptions. Content with the operating knowledge of FTA or cable, many of this agegroup are yet to fully embrace the streaming alternative.
In a recent study by Ampere Analysis, older users (age 55-64 years old) were the fastest-growing age bracket of AVOD viewers, with a 7-percentage point increase in AVOD uptake among the group in the last year alone.
That said, let’s not overlook or underestimate how Netflix can take advantage of the audience willingness to rewatch favourite serial content. That’s a propensity not the preserve of Netflix. Whether it be I Love Lucy, Game Of Thrones, the full set of Star Wars or Star Trek, House Of Cards, The Office, Friends, Orange Is The New Black or The Crown, audiences have been paying for and watching re-runs on FTA, cable and streaming services for decades and they continue to do so. It’s still headline-worthy today when these titles are licensed to other channels. Netflix by comparison is increasingly replacing back catalogue content with their original content, which will have rerun appeal and they can elect to license to other channels for revenue later in life.
Netflix does need to keep making original content, and for now, they seem to have settled on an output that fits their capacity to finance and manage while meeting audience demand. This could explain why the originals content budget for 2021 of US$17 billion is unchanged from 2020, despite the earnings surge.
Netflix continues to boldly march to the beat of their own drum, playing the long game because it understands the value of the exclusivity of their content asset and the deeper requisites of satisfying customer experience. Netflix is half an entertainment company and half an IT company, with a complex value proposition, so both sectors must work hand in glove to deliver a product supremely valued by the customer.
Harnessing A Position of Power
Netflix is not competing purely on price or hours of content. They compete to be the first choice of streaming entertainment by being a very satisfying streaming television service with something on the screen for everyone in the household.
As we know, last year Covid had us locked indoors, reaching for the remote, and this caused a massive spike in streaming subscriptions for all services, including Disney+, but especially for Netflix, the more established subscription streamer. As a comparison, Netflix added 15.8 million new global subscribers in Q1 2020, actually double the company’s and Wall Street analyst’s estimates in the previous quarter.
The Covid silver lining for Netflix came in Q4 2020 results when Netflix grew operating profit 76% to $4.6 billion in Q4 2020. The unexpected ‘shot in the arm’ Covid delivered to their financials means that at present, there is no imperative to compromise the value of their content catalogue and UX for short-term financial gain by selling advertising.
|Netflix Operating Year||Total Global Streaming Paid Memberships||YOY Change||Total Revenue US$ BILLION||YOY Increase||Net Income US$ BILLION||YOY Increase||Budgeted Spend On Original Content|
Backing Better Content
Netflix took a bold strategic position on original content years ago in 2011 when it commissioned its first drama series with two seasons (26 episodes) of House of Cards, (estimated value between US$104-156 million). In the ten years since, the Netflix catalogue has outdone all others, for its commitment to new content in terms of deals with top creative production talent eg. recently inking a deal with Steven Spielberg’s company Amblin Partners, sheer volume of content and financial investment (see table below). Incidentally, 90% of the value of a show is expensed within four years of its debut.
Netflix produces predominantly premium content produced by the best creative talent with high production values. They effectively suffocated competitor studios to some extent, by securing the oscar-winning, top producers et al to make shows for Netflix. They committed to their content, and they paid them. This investment is paying off in content that wins audiences and awards.
Back in 2018, there was buzz (or incongruous disbelief) at the fact that Netflix was committing to US$12 billion of original content creation, with some of the best creative production talent available in the US. In a very insightful and rare interview published by Vulture Beat, Netflix’s chief content officer at the time, now co-CEO Ted Sarandos said:
“I‘m building a team that’s oriented as saying ‘Yes‘ in a town that’s built to say ‘No‘ ”
If you’ve ever tried to have your concept green-lit in Hollywood, that quote will resonate with you.
“To stimulate volume, Sarandos and Holland have put in place an extraordinarily decentralised development and production pipeline, one that allows Netflix to operate like ten or 15 semi-independent entertainment companies — whose output all happens to be distributed by a single service.” Vulture Beat
They ostensibly dropped the concept of producing pilots, saving millions by going straight to series. They introduced releasing an entire series all at once for ‘binge watching’ instead of one episode per week as was tradition. With no advertising structure to work around, this was a freedom they could indulge. It viewed audiences around ‘taste clusters’, reflecting less restrictive preferences than pure demographics.
They use their technology to monitor and affect viewer behaviour, observe individual content preferences, and promote content consistent with viewer’s previous selections. They watch what is watched, when, for how long, by whom, and this helps refine their content strategy to make more of what resonates with viewers. Note to analysts: this is known as ‘customer-centric marketing’…
Where To For Growth?
The Netflix international expansion is still underway, and various customer acquisition strategies are in play. Chief among these is their entry-level mobile plan, which provides an affordable entry-level experience to consumers in high volume, low-income regions such as India. The mobile plan has been rolled out to 78 countries.
BTW here’s a handy tip from comparatech.com:
You can access Netflix catalogs from different countries when traveling abroad with a VPN. However, not all VPNs work with all Netflix country catalogs. We recently tested 59 different VPNs with 30 different country catalogs so be sure to pick a VPN that works with the Netflix country version you want access to. You can see our list of recommended Netflix VPN services here. (as at March 2021)
Netflix accounted for seven percent of total TV viewing in June (YouTube follows at six percent), but most TV viewing is still with broadcast and cable. Old habits die-hard, but consumer behaviour is shifting toward streamed TV, and the largest growth sector is in audiences age 55+ years, who are still trying to get their head around the streaming TV alternative.
So the post-earnings share price is not necessarily a reflection of Netflix future growth or earnings potential. I suspect growth will come over the longer term from continued market expansion, as well as brand extension by –
Consolidating and securing audiences around a broader Netflix streamed entertainment offering which will include:
- Market penetration as the number of global Internet users grows (Netflix currently has around 11% of global Internet-connected consumers. As the number of connected consumers grows toward four billion, even if Netflix retains 11% market share, there is growth in subscribers for Netflix.)
- Market share by converting viewers aged 55+ to Netflix
- More original content of cultural distinction eg. By country of origin (which will bring distinct creative attributes to the content that will foster regional subscriber loyalty)
- More original content licensed from independent producers using Netflix distribution
- Original video game product, which will ultimately include AR & VR
- Original ‘partnership content’ ie. commercial entertainment (read new form of advertising, the new ‘branded entertainment)
- Improved UX through advances in content delivery technology (this area of technology I propose will be an area of acute acquisition interest to Netflix)
- Expanding audience interaction to real-world physical experiences such as events and merchandise opportunities
- Licensing some of their aging original content catalogue to other channels
The ‘bulls’ love a winner and enjoy riding a strong growth trajectory, but the ‘bears’ among analysts and investors lie in wait, ready to pounce on the first sign of weakness. For most stocks, performance figures like these would be cause for a share price upswing:
- Revenue increased 19% yoy to US$7.3 billion
- Operating income rose 36% yoy to $1.8 billion
- An 11% increase in average drove revenue growth paid streaming memberships and eight percent growth in average revenue per membership (ARM).
- Operating margin of 25.2% expanded three percentage points compared with the year-ago quarter.
- EPS of $2.97 vs. $1.59 a year ago
- Added 1.5m paid memberships in Q2, slightly ahead of Netflix 1.0 million guidance forecast
The APAC region represented about two-thirds of the additional subscriptions, and the eight percent growth in average revenue reflects customer satisfaction with the service in their willingness to pay more. This is why the interpretation of the statistics, the data, the numbers need more fundamental analysis and insight to evaluate the strategic benefits Netflix has been building over the longer term.
Netflix was the first to –
- boldly grow the SVD subscription market
- adhere to a subscription revenue model
- reinvent the work environment to empower talent and give freedom with responsibility
- undertake ambitious international expansion
- make a significant commitment to original high-quality content
- reinvent the studio model of green-lighting content creation
- secure the best quality creative and production talent to ensure supply beyond initial output
- invest significantly in local content in international territories
Netflix is not immune to the forces of competition, but they do have a formidable position of strength that includes:
- innovative management with a proven track record of success of an original approach to media and entertainment
- a global digital and physical footprint
- significant regular monthly revenue
- contractual engagement with an impressive array of creative production talent
- budget to support and fund established and emerging international production talent
- an established service
- strong brand
- consumer acceptance
Netflix isn’t competing to have the best EPS, quarterly membership ads, annual original content productions, net or gross revenue. Netflix is competing to be the number one choice among many alternatives for streaming entertainment. That’s a position that factors on a whole different set of benchmarks, not much explored by the analysts this week.
So next quarter I hope to see more discussion and debate from the analysts and industry commentators on how Netflix will harness and benefit from their other resources and assets.
In my experience, a customer-centric approach relying on ingenuity, boldness tempered by prudence, tenacity and humility, often trump money.