Stream Wars

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by Peter Jones, CFA
Vice President, Equity Research

A couple of months ago, Netflix announced it would be losing the number one most-watched show on the platform, The Office, in 2021 to NBC Universal (owned by Comcast) who had acquired it in order to promote their new streaming service set to launch next year. A few weeks ago, Netflix announced it would be losing the number two most-watched show on the platform, Friends, in 2020 to Warner Bros. (owned by AT&T) in order to bolster their own streaming service which will launch in the fall. This week, Netflix reported net subscriber additions of 2.7 million in the three months ending June 30, which was far short of consensus expectations of 5 million. In the wake of these announcements, Netflix stock is now down 16 percent from its recent high.

Several Wall Street analysts and investors have cited upcoming competition from Disney offerings Disney+ and Hulu, Warner Bros., NBC Universal and other streaming platforms as a big risk to Netflix’s dominant position in the streaming world. The aforementioned content losses and subsequent miss in subscriber numbers has served to add fuel to this argument. While we agree that increased competition may slow the pace of subscriber additions and limit Netflix’s ability to raise prices, we doubt that Netflix will experience much, if any, attrition to these services. Netflix is far too entrenched to be dethroned any time soon: the competition is too late. A few years ago, nearly all the content found on Netflix was licensed from major cinematic and TV studios like NBC, Universal, CBS, Warner Bros., Pixar, ABC, HBO, etc. However, today, nearly 50 percent of the content found on Netflix is produced and owned by Netflix. This number is only going to increase in the coming years. Further, all the major hits as measured by concurrent viewership are Netflix original content. This is hugely important because even if the major studios were to claw back all the content Netflix licenses, Netflix would still have an incredibly viable offering, enough to entice consumers to continue paying $13.00 per month.

While we disagree with the argument that Netflix is going to lose subscribers due to mounting competition, we have other concerns, namely spending and valuation. Netflix explained that subscriber additions were weaker than investors expected because of the timing of new releases. Simply, there were not enough Netflix originals released in the second quarter. In other words, Netflix must continue to pump out a substantial amount of new content each quarter in order to attract subscribers. If Netflix’s growth is incumbent upon new content, rather than “library” content, Netflix is going to need to continue spending at an incredibly high and increasing rate. In fact, new subscribers and spending have moved in lockstep over the years (chart below).

Source: Goldman Sachs

Source: Goldman Sachs

The problem for Netflix is that they have not yet reached the point of inflection where the subscriber base is sufficient to generate revenues larger than the spending required to attract and retain customers. Rather, alarmingly, Netflix has burned cash at an increasing rate every year.  

Source: FactSet

Source: FactSet

While we are not recommending a “buy” or “sell” on Netflix, our concerns are different than the headlines. Namely, we do not worry about Netflix’s dominance in streaming, but instead, are highly concerned about the cash cost of maintaining their position.

In the end, we do not believe TV streaming is a “winner takes all” or zero-sum game. There is plenty of room for several companies to succeed. In fact, the real winner in the disruption of traditional television consumption is the consumer. Ten years ago, everyone had to purchase essentially the same package, or “bundle” from cable companies no matter how much of it they watched. Today and in the future, consumers will be able to purchase different streaming services a la carte, at a lower total cost, and thus create their own bundle based on their own preferences.

Our Takeaways for the Week

  • Competition in the streaming arena is heating up

  • Netflix is too entrenched to be dethroned, but defending their position looks to be costly

  • The consumer is the ultimate winner of the streaming wars