Netflix is starting to act like a new age TV network.
The second quarter figures this week revealed more subscribers than thought, higher revenues, more profits, and expectations of more of the same this quarter. And the market responded positive, sending the shares up more than 13% in four days to just over $US183 at the close on Thursday where it is worth $US79 billion.
But the earnings statement and a surprise disclosure from the streaming video pioneer reveals it is really little different than the linear TV businesses it is seeking to replace.
But unlike follow disruptors like Microsoft, Uber, Amazon, Google and Facebook and their apparent desire to dominate, Netflix thinks there will be room for a lot of successful streaming operators in coming years – which includes the linear companies as they change as the likes of CBS NBC and Fox in the US and Nine and Seven here are doing.
Netflix’s second-quarter saw a record 5.2 million new subscribers signed up in the three months to June, against the company forecast of 3.2 million. Total number of US and international subs passed the 100 million mark early in the quarter and ended at 103.95 million – 4.1 million came from international markets, 1.07 million in the US (which was almost double the 631,000 forecast by analysts). The company expects to add a further 4.4 million this quarter
Revenues jumped 32% to $US2.79 billion for the quarter, with net profit up 60% to $US66 million. For the current quarter it expects revenues of nearly $US3 billion and net profit of $US143 million.
But the real interest was in the document Netflix released discussing its content planning and costings (http://files.shareholder.com/downloads/NFLX/3290970317x0x949425/845E0B50-9FF6-41B4-BCDF-12634FB0004C/Content_Accounting_Overview.pdf), the first such disclosure from the company. In it it explained its costings of content, its revenue recognition policies, its outstanding commitments and its key amortisation policies (which is where a company can manipulate earnings with relative impunity).
Netflix says it has about $US15.7 billion in content obligations (that’s spending on program making) at the moment, and admitted that it doesn’t have ‘visibility’ into a likely $US3 to-$US5 billion more over the next three years. That’s spending that may happen depending on program success and it doesn’t know the exact cost because storylines, casts etc have yet to be completed.
Netflix said 93% of its current own content has been renewed. While that’s higher than at most TV networks, is an interesting revelation because the company is starting to act like a normal TV network (even though there are no ratings in the way conventional linear TV (Free to Air and cable is rated).
In the second quarter, Netflix flicked both the costly high-concept science fiction show Sense 8 and the musical drama The Get Down because of weak viewing numbers (against their high cost). And Netflix CEO Reed Hastings made it clear that the company plans to exert more programming discipline in the future.
But the document does outline why programs get renewed or axed – it’s all to do with viewer reaction (the number of streams)
"We strive to be bold in our programming choices and financially disciplined, so we can keep being bold. Every show has passionate fans and committed talent striving for excellence.
"Sometimes those shows don’t attract as many viewers as we had hoped, compared to our other content. As much as we dislike ending a series early, it consoles us that it frees up investment for another new show, or two. We are programming to please our members and we keep that as our guiding light.”
Shorn of its US touchy feely wording (“passionate fans”, “it consoles us”” programming to please our members” and “our guiding light”), this statement would not be out of place in the briefing notes for the likes of Fox, HBO, CBS, ABC (US), ITV or Nine and Seven in Australia. For all its newness, streaming video is still measuring itself using ideas fashioned from linear TV.
"Creating a TV network is now as easy as creating an app, and investment is pouring into content production around the world. We are all co-pioneers of internet TV and, together, we are replacing linear TV. The shift from linear TV to on-demand viewing is so big and there is so much leisure time, many internet TV services will be successful.”
And for accounting/analyst nerds Netflix’s amortisation policy is conservative – for example, talk show and similar topical first run programming is expensed upon airing, and content lives generally are amortised over the “shorter of the title’s window of availability (saw in films from other producers) or maximum useful life (for its own content).
Netflix says its amortisation period is six months to 5 years on average and never more than 10 years. “The vast majority of our content is amortised on a accelerated basis” The company says the schedule with amortisation is based on historical and estimated viewing patterns and reviewed every quarter. “90% of amortisation occurs within the first four years of being available onsite for original TV series and films.”
The company’s amortisation bill in 2016 totalled $US4.78 billion, up from $US2.65 billion in 2014.
Costs, overheads etc associated with each production is capitalised until broadcast, then amortised according to content type. This will all make analysing Netflix easier. Now pressure will build for another rise in monthly subscription charges to customers.
Netflix’s US subscription rates currently range from $US8 to $US12 per month – HBO costs $US15 a month.
How it plays that one (after taking a small hit last year from its last fee increase) will tell us how much Netflix is changing from being a bright ’new’ tech company to a more traditional media operator.
And it is an increasingly expensive business (as Free To Air and Cable TV executives can tell Netflix). It is locked into contracts requiring it to pay more than $US13 billion for programming during the next three years, which has forced the company to borrow to pay its bills.
After burning through $US1.7 billion in cash last year, Netflix expects that figure to rise to as much as $US2.5 billion this year. This requires the company to operate with negative cash flow – normally an alarm bell for analysts and investors. Mr Hastings described the negative cash flow as “an indication of tremendous success,” reasoning that Netflix wouldn’t be able to finance new programming if it wasn’t attracting so many new subscribers. But one day, soon,investors will start wanting to see higher profits and then Netflix will be an ‘old line media company.’
