Netflix Management Presents at Morgan Stanley Technology, Media & Telecom Conference (Transcript)

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 |  About: Netflix, Inc. (NFLX)
by: SA Transcripts

Scott Devitt – Morgan Stanley

All right. We’re going to get started. I’m very happy to have David Wells, CFO of Netflix with us.

David Wells

Thanks, Scott.

Scott Devitt – Morgan Stanley

David, I have a long list of questions, but I think given the number of articles that have been written on the Comcast deal and probably the amount of misinformation that’s out in the market, maybe just give you a forum to speak to the extent that you want to share what you want to share about the relationship and how it affects the business. You have an open forum to do so.

David Wells

Sure. So I think it obviously is the first question on people’s minds. For us, it was important because it was an opportunity to shore up the long-term subscriber experience. So there was Comcast subscribers. There definitely was some choke points around peak period usage times. And for us, it’s important to ensure a great quality of experience for the service.

I would say we are going to be consistent with our guidance on 400 basis points year-on-year margin improvement for the U.S. streaming business. So you are hearing me confirm that nothing has changed there. So you should conclude from that, that the deal in terms of the cost for that, yes, it was incremental but it wasn’t incremental to the point where we’re changing that. I would say that we still philosophically believe that the consumer is still best served in an environment where a content provider like ourself doesn’t pay an ISP.

That consumer pays for broadband. And we would say that they should be able to use that broadband, but it was an opportunity for us to ensure better service long-term for our subscribers.

Scott Devitt – Morgan Stanley

So that better – as I’m hearing you, better service, some incremental costs to this relationship. Is that something that you would anticipate expand to other providers over time?

David Wells

Well, it could. I would say there is an acknowledgement here that not all ISPs are created equally. It certainly could expand, but to the extent that it’s about the cost of that. For us, we’re not going to be interested in doing something that’s going to meaningfully change the economics for us on that, but we are interested in doing things that, for the right set of economics improve that subscriber experience long-term.

So I think we’re somewhat caught in the middle in terms of being very oriented towards a long-term subscriber high quality of experience, and protecting the innovation on that front, down the road in terms of HD and other high quality high bandwidth uses of entertainment, but being mindful of the environment we’re in today.

Scott Devitt – Morgan Stanley

Okay, good. And we’ll have time for Q&A at the end to the extent if anyone has further questions on the topic, but shifting gears to what I think is a bigger part of the story which is sub growth, domestically and internationally and starting in the U.S. business, you no longer disclose churn. And so, as we look at kind of the 60 to 90 million sub opportunity in the U.S., Reed’s comment on the last call in terms of being in the middle of the escrow in terms of adoption. How should investors think about where the sub growth is coming from right now in the U.S. in terms of lower churn versus more customers into the funnel?

David Wells

Well, it’s coming from both places. So you wouldn’t get the type of growth that we’re seeing just from a pure churn improvement unless you went to zero and that’s not going to happen. So I think you should conclude that it’s coming from both places, right. We’ve said in the past that our rejoin rates of about 30%, 40% are still there. So there is a predominant share of subscribers that are not – that are coming in new.

We’ve also said that we’ve seen retention improvement, and we will continue to see those. So we’re really pleased about the progress that the service is made domestically over the last 12 to 18 months. We have improved the content. We have launched several successful originals. We have improved the perception of the other classes of content within the offering. We’ve improved the interface, and I think you’ve got a question later on about some of the things in the product side that are improving. And so we’re really pleased with that. And that all translated into a much happier customer, which translates into better retention growth.

Scott Devitt – Morgan Stanley

Okay. And then on that topic to the extent that original content has been a driver of lower churn potentially. Ted has been out in the market and talking about some pretty big numbers in terms of the number or originals that I think is his aspiration personally, with the impression the company is going to go. Reed has made some different comments publicly. How does the company think about original mix in terms of percent of dollars spent, and how that changes kind of the sustainable advantage of the model over time?

David Wells

Well, I think to reconcile some of those comments because I found myself on either side of trying to reconcile those. I would say we don’t have an end percentage of mind in terms of whether the company evolves to an 80% original, 20% non-originals company. I would say we’ve seen some really good success early on. We’re going to continue to double that level of investment, but it’s growing from zero, and it takes a while just from the creative lead time of choosing high quality projects to broaden out that portfolio off of.

So we have a commitment. As long as we’re continuing to see the success that we do to grow it, whether that become 50% or 70% of our overall libraries content spending, is unknown. I do know that it likely will never get to 80%. HBO has been in the same a lot longer than we have, somewhere around that 40% to 50% range. And they seem to be somewhat steady there in terms of how much they are willing to put to it. And that’s worth 10, 15 years of experience.

So I would say expect us to continue to grow it and we’ll grow it at a level that we’re comfortable that we’re adding quality along the way. And we’ll experiment on each margins, whether it’s good to add another one and another one. It’s our intent from a consumer – not the business perspective, from the consumer perspective, it would be great to get to a world where we’re releasing one or two every other months every month show that you’re engaged in the consumer, not everyone watches the same thing.

So in order to do that, you have to really 15, 20 per year whatever that number is going to be. And that’s where we want to get to.

Scott Devitt – Morgan Stanley

And then beyond originals, it’s suggested and I think that you all shared this as well that the data that you have is very unique in terms of the scale of your company, the data you collect allows you to make decisions that other providers may not have the data to make. And there is examples like breaking that in [indiscernible] where being on the Netflix service actually influences the success of the show. And so the question is, within your negotiations with studios in terms of the accessing content, how does the data that you have and the influence that you are beginning to have on some of the shows affect your negotiations with them relative to have the providers that were running at the same content.

David Wells

Well, I’d say both on your question on original then on license content. It’s helpful to have the behavioral data in terms of what people are viewing, what they really watch. Is it 80% deterministic of a successful licensing deal or a successful original? No. There is no excuse or substitute for execution as I said in the business.

I would say it’s helpful. So is 20% to 50% helpful? Sure. In terms of being guided with what the potential audience base for particular show might be and thinking about how many of engagement that might drive in battling into a budget or just to what we might be willing to spend. Yes, it’s helpful.

Is it helpful from a recommendation perspective where we launch on a platform where we can recommend to you House of Cards, because you might have enjoyed the British BBC original. You might have enjoyed other political thrillers and we can chain you to another piece of content, absolutely. And that has more to do with the benefits of the distribution platform, than it has to do with the narrow value of having those behavioral data on whether you would watch a show or not. So I’d say it’s helpful. It’s not a primary determinant characteristic of success.

Scott Devitt – Morgan Stanley

And I think it’s been said also that no single content deal has disproportionate impact on the overall viewership. And so there is evidence as you diversified the strategy in terms of the content and the fact that you don’t have all the content but you have the ability to go in one direction or the other which gives you flexibility. The question is, there is a couple of deals particularly said, Disney Marvel content as it relates to children’s content. And we’re just wondering, are there any deals that one in particular that is game changing or more significant in terms of the value that it can have to the system?

David Wells

Well, I wouldn’t put anything in a game changing category other than the success we’ve had with originals. That to me is a big game changing in terms of the perception of the Netflix brand. Globally, it gives us a very solid marketing anchor in terms of driving what Netflix stands for in a very solid brand anchor, but in terms of particular titles or particular content deals, there is nothing game changing.

Some may be larger than others, but we’ve proven through over the last three or four years that we’re fairly disappointed from an economic standpoint in terms of thinking about how much something might be worth. And if we reach a point where we’ll pass comfort level, we won't sign up for that.

That said, it’s important to us to build a breath of offerings that you see us rounding out a lot of different categories of contents.

Scott Devitt – Morgan Stanley

And shifting gears then to international which is increasing component of business. You noted embarking on a substantial European expansion later this year. We’ve tried to make some guesses ourselves in terms of what the potential drivers are and market decisions that you make, and how quick adoption is. The question relates to ’14 specifically, the markets that you’re contemplating the timeline and the rollout to the extent that there is anything that you can share around timing in ’14, and how that will affect the cost structure of the business given the content acquisition that has come up?

David Wells

Sure, I maybe iterating comments that you’ve heard already, but just in my one-on-ones I think there was some people that weren’t even aware of some of them, but we have said that we would have a significant expansion, and that word significant, is applied to the people don’t take it’s equivalent to the Netherlands expansion that we had last year. So it would be larger than that in the back half of this year.

So again that was somewhat news to people that may not have closely read our letters or comments. It’s not going to be this quarter or next quarter. It will be the back half of the year. So we’ll have more to say more towards the middle of the year in terms of flushing that out. There is plenty of speculation out there that there has been no commentary from us in terms of what that might be.

Scott Devitt – Morgan Stanley

And what – so simplistically it seems like broadband accessibility and the content that you can acquire are the two biggest drivers of the decisions that you make in terms of when you go to a certain market. Are there others and how significant is each?

David Wells

Yes, I would say that those two factors haven't changed. They’ve been there forever. I think there is speculation about the fact that Netflix is now more established and potentially more of a threat to incumbent players in certain territories that we’re not in, but there is an ability for them to lock rights up. There is some truth in that in the sense that they have a lead time to license content, but the reality is Netflix has come along and established a value for digital rights.

So you can't lock up everything for free. There is no such thing that’s sucking the oxygen out of the environment. You might have an incidentally small market where that is true but generally that’s not the case. So if you’re going to do that and lock up rights, it’s going to cost you money and there is a cost to that.

So there is an infinite cost to try to suck the oxygen out of the environment. There is something acknowledging on our part that, now that we’re established and there is a little bit more an expectation that we’ll be an eventual player in the market, that there is people playing defensively and yet that’s incrementally negative for us.

On the flip side of that, we’re much larger, than we were, say even 12 months ago internationally. And so we can bring to bear a global distribution platform, both from a content licensing perspective and from just taking through the value to a content player, especially if you’re a smaller player like a documentary or an independent film, we can provide you with an audience of 30 to 40 million and growing and growing global subscribers which is very valuable.

Scott Devitt – Morgan Stanley

And how portable is the content portfolio? It seems like English language markets versus non-English and the ability to have some portability in terms of the content portfolio is also an been accelerating. Is that fair?

David Wells

To some degree, yes. So I would just point out that, sure we’ve been in both the English friendly markets of Europe or the U.K. Nordics, and the Netherlands, but we’ve also been in Latin America for over two years. And certainly aspects of that market is not English or English language oriented. And we’ve been successful in growing in that market as well.

So it’s not just that characteristics. I would say the characteristic that we benefit from, and all of us in this country benefit from is the fact that the market is large, our production budgets for content are large, which means the quality is good. And therefore there is a large demand for Hollywood and Western produced content outside the U.S. And Netflix to the extent that we go in that market with 80% of that and 20% of local or other market content, that hits our sweet spots.

Scott Devitt – Morgan Stanley

There is – and correct me if I’m wrong here, but just been reading media enforcement that are available, it seems like there is content like House of Cards as an example where it’s original content but not necessarily owned by Netflix, so there is some markets where there is other providers that have access to that content. Can you speak for that in terms of the strategy around fully capturing the opportunity? And then secondly we’ve had questions from investors around the willingness for Netflix overtime to actually integrate and actually own a studio in the way that Amazon has been testing?

David Wells

Yes, so with your first question, yes, it’s true that there are certain early originals where we may not have the license in that territory. At the time of signing the deal, there is an opportunity cost to us that’s real, saying, okay, if we not anticipate all markets. If we don’t want to pay for global license, that’s a real cost. So we either let those go or we strategically sign up forum and we would under-monetizing and we’re not using it potentially for a long period of time.

So there are several originals where we sort of made the decision. I would say, no one joins Netflix because of one title. You should expect us to be more and more exclusivity oriented around our originals projects with the early on, yet there is a couple of territories where we were not going to launch first run in the market. We’ll still have them available that they won't be premiering on Netflix. That will fade overtime.

And then your second question just remind me was more on the…

Scott Devitt – Morgan Stanley

I forgot the second, so I’m going to skip it, since we’re on stage. Because I was already think about the next one which is one net neutrality. And to the extent that there is overlap in terms of the Comcast situation in net neutrality or there is not. Can you just speak to that in terms of [indiscernible].

David Wells

Sure. I think that there is less overlap here. Net neutrality is very narrowly in the realm of the SEC order and the overturned Viacom challenge and overturned by the court has to do with preferentially or not preferentially treating your bits as they stream to the consumer differently than say some other services. That wasn’t happening. So the ISPs all of them were not doing that. There was no flaunting [ph] going on in that sense, right.

I think not only with the consumer not stand for that, but I think the ISP would acknowledge that really invites government scrutiny and that’s not in their best interest. So to that extent, no, that wasn’t going on. What we were talking about was how transit – how we get those bits to the last mile consumer, to the ISP. How much does that cost and the network architecture involved in doing that.

Our open connect program essentially takes equipment that we pay for and puts it into the within the ISP data center and it takes out that transit, what’s called transit across the internet, it takes out the cost for the ISP and it takes it out of the equation in terms of the latency period when you’re pressing play or when you’re playing something, there is less sort of miles that have to occur in the table. And that’s more about what the deal is about is the terms of trying to strike a deal where we’re closer to the network architecture of Comcast, the data centers so that we could provide a better service.

Scott Devitt – Morgan Stanley

Okay. One last one from me and then we’ll open it up to questions, and just wait for microphone to come to you. On pricing. In the shareholder letter, you talked about testing the 699, the 799 and the 999 to manage both I guess at a lower cost option and also a password sharing. And how prevalent is that in terms of an opportunity to have consumers trade up, and what do you think the risk is of any if you go more aggressively in that direction understanding that you’ve made a commentary of generously grandfathering in existing customers?

David Wells

So I think we’ll be consistent on the grandfathering concept. It was a lesson learned from 2011 and it’s just good for the consumer for the change. I would say in general, ground sharing, we’re still passing a number of concepts. You should expect us to test those concepts where we’re not in a general hurry.

When we get comfortable that we’ve got a good long-term concept, you’ll see us apply that. And the hurdle to overcome with the economics theory of belief that when you a large market like we do, 30, 40, growing 50,60 potentially million subscribers, one size does not fit all in the price standpoint.

So from an efficiency – again from a pure business or an efficiency standpoint, you’re match better off offering choice in that market to the consumer and letting them sort of fill that in terms of both ability to pay and also value in terms of how much they weigh. So I think that’s where the spirit of the cheering is coming from is a belief in that. And the hurdle would be that that’s better than just taking about a straight across the board a dollar increase.

Still in a better place from a business perspective. Economically, entering a better place from a consumer perspective from a choice.

Scott Devitt – Morgan Stanley

And still open-ended timing wise, right? Okay. Let's pause there and see if there is questions, just wait for the mike to come. Up in the front.

Unidentified Analyst

Thanks. How important is broadband speed in your international markets. So when you expand to Europe, obviously the Netherlands have higher broadband speed than Latin America. Can we do a faster ramp with a big market opportunity than maybe in terms of more in Latin America?

David Wells

So the question was broadband speed. There is a Bernstein Report that came out talked about broadband speeds and the opportunity outside the U.S. being smaller than what people think of the PWC’s [ph] studies that 700 to 800 million global broadband households. That one particular study reference four megabits per second which is pretty rich from a quality perspective.

Today, you can get a Netflix signal in 500 kilobits per second, that’s an eighth of what was referenced. We recommend 1.5 in terms of getting to that high quality. We are under much more restrictive usage caps in Eastern Canada than we are in Western Canada or in other parts of the world, and we see consumers in general can live with lower average bit rates. I don’t think we’re in a world where we need two, three, four.

When you’re talking about 4 K&H [ph] and Super HD, then you’re definitely in a world where you need those, but I would say we’re pretty happy with what we see already in place in Latin America today. Could we benefit from continued improvement and will we? Yes. If that market will continue to grow a number and grow in average broadband fee, because they are just too many applications that use the internet that make it important, that mean the infrastructure will become important back to the industry and the country and also the consumer.

So we’ll draft off that tailwind. And then in the established markets in Europe, they have highest speeds than we have in the U.S.

Unidentified Analyst

I just had a technical question. Your contract with Disney of the film, when does that go into effect in terms of when something is distributed to the theaters, when would you be able to show? Is that only Disney films or does that include Marvel and the other studios?

David Wells

So we have – I think you’re making reference to the Disney Pay one deal that we did, which was – the content will start flowing in sort of the back half of ’16 and ’17. So it will be a little bit of a time. Obviously when we make a long-term deal like that, we already know that from a budget perspective and we factor that in.

But it will be a little while before that content starts flowing on the site. Today, you already have a lot of high quality catalog content and you have DreamWorks and other things that have newer again pay one release. And in terms of the Marvel, we haven't talked specifically other than to say that there is aspects of both Marvel and Lucas that will also be part of that deal, but it will be a while for that content as well.

Unidentified Analyst

So Scott, was asking about where you guys might move to in terms of owning content. I read I think before the question sort of got lost. So currently original content spend is around 5% and you identified it as groundbreaking. So I’m just wondering the extent to which you’re going to ramp up original content spend over the intermediate to short-term. And do you guys have any internal dialog about creating content outright and owning it in that matter?

David Wells

Sure. We’re already ramping it up pretty aggressively, but when you ramp up from zero, it’s not – you don’t get to the levels of a third of your spend. They are going to be in this category. So yes, we’ve talked in the past about less than 5% ramping to 10%. You’ll hear us talk a little bit less about the specific percentage because it’s not like we have a specific percentage in mind.

We are going to continue to growth that aggressively. That said, there is a lead time in the creative process, and to the extent we have a commitment to the quality of the work that comes out, it means that we’re not going to suddenly double, double. It’s our intent to double, double but from a spending perspective it’s going to grow in terms of that percentage of the overall spend.

And then your second question was more on the structure of the ownership. I would say and some of you’ve heard me say in the past, Hollywood has a number of successful production model, anywhere on the spectrum from full ownership, fully integrated all the way through other end of the spectrum totally arms linked license deal that’s much more like a syndicated TV, but I would expect us to continue to have originals project all along that spectrum, but to be oriented a little bit more and more towards ownership.

What was important for us early on and is still important for us is a long-term deal unlock in the digital VOD space for a long-term for pay one, and essentially a pay one deal. And that’s still important and that’s the primary right that we’re after.

And to the extent that we think that we can do – produce the content more efficiently if we own it, where there are some accrual benefits of protecting some of the marginal non-exclusivity elements then we would do that, but it’s the primary thing is that the how much does it cost, how much is it viewed and do we have a long-term right over that dealing?

Unidentified Analyst

I just had a question on your quarterly earnings format. Something like 99% or above companies in the U.S. have quarterly call with a number of analysts and investors. They have a diverse group of opinions. Usually that call lasts over an hour. Netflix has chosen to go to half an hour with just two analysts who to extremely bullish on your stock. I was curious why that is, and I was also curious if you would go back to a format that allows for more participation from a more diverse group so that we could better understand your company.

David Wells

Well, so I would take issue with the fact, if Rich and Doug are bullish, it’s not because we chose them, right. So we have some intention to sort of rotate a little bit of those two facilitator interviewers. We feel like it’s very inclusive in the sense that you could email questions to the extent that they are non-repetitive and they are viewed important, they will get asked.

So we’ve gotten many compliments on our process from buy side, sell side. And so it’s our intention to begin to a little bit of rotation in the interviewers, who wanted the competency of doing it to take hold and not lose that by constant rotations. But I think that we’re getting lots of questions in and the efficiency of the process is high. And you may not agree with that, but I would say generally that’s what we hear about.

Scott Devitt – Morgan Stanley

One last question.

David Wells

Sure.

Unidentified Analyst

Given though that data that you guys are collecting and will collect as users grow and streams get large, I guess is there any point at which you’ll switch or at least offer some type of advertising platform for let's say subscription where to be able to better monetize that data?

David Wells

Well, I would say no. It’s just a quick answer. Netflix has been about core non-advertising subscription. So I wouldn’t expect that to shift off that. And just a final point, so Scott had a sell on and I am being interviewed by him.

Scott Devitt – Morgan Stanley

He has to bring that up now. I thought I got passed though when I went back to [indiscernible] but I guess not. David, thanks a lot for spending your time with us, we appreciate it.

David Wells

It’s already ended [ph].

Question-and-Answer Session

[No formal Q&A for this event]

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