Netflix And Its $1.2 Billion Spend On Original Content

| About: Netflix, Inc. (NFLX)

Summary

NFLX is expected to invest $1.2b on original content this year.

Given the decelerating domestic subs growth and content inflation, original content will be a key differentiator for NFLX.

Remain on the sidelines due to elevated spending and execution risk. Prefer studios over media distributors.

An article in the Hollywood Reporter stated that research group Ampere Analysis expects Netflix (NASDAQ:NFLX) to spend $1.2b on original content this year. A quarter of the spending is expected to be titles produced outside of the US, such as the upcoming "Crouching Tiger, Hidden Dragon" that is scheduled to be released on February 19th. In addition, NFLX also is expected to invest up to $143m for the first two seasons of "The Crown," an epic drama about the history of the British royal family. Given the content inflation NFLX is seeing globally and the need to differentiate its platform from other OTT services, original content will be a bigger focus for the streaming giant.

Although this is certainly the right direction, elevated spending on original content will continue to pressure profitability. Put it another way, I like the strategic move but skeptical of its success rate based on only "House of Cards," "Orange is the new Black" or "Narcos." I need to see consistent execution on content origination before I become comfortable with the stock. Keep in mind that companies such as Disney (NYSE:DIS), Time Warner (NYSE:TWX) and Lions Gate (NYSE:LGF) have a more proven track record of content production whereas NFLX is still relatively new in this area. As such I remain cautious on NFLX and reiterate my preference for the content owners rather than the content distributors.

In my view, NFLX is facing several secular headwinds in all of its key operating geographies. In the US, competition is increasing from alternative OTT providers such as Hulu, Amazon (NASDAQ:AMZN), YouTube (NASDAQ:GOOG) (NASDAQ:GOOGL) and HBO and this has been driving the decelerating domestic subs growth that we have been seeing over the past several quarters. As such, NFLX is relying on international growth to offset its slowing domestic growth and its recent aggressive expansion across 130 countries implied a sense of urgency in NFLX.

Besides subscribers, growing content also is important. Quality content is the key determinant of ROIC for the SVODs because it differentiates NFLX from the other platforms. However, investors should be aware that content inflation will remain elevated as SVOD and studios contend for the top talent and stories. I note that "The Crown" will cost $143m for the first two seasons, which is 43% more than the first two seasons for "House of Cards." Higher spending on original content will continue to weigh in on NFLX's profitability and it is still too early to determine whether the upcoming NFLX originals will be successful, which is why I recommend investors to stay on the sidelines for now.

Conclusion, NFLX is making the right strategic moves but I'm concerned about the near-term spending. Investors are better off with content holders given that they are better positioned for the OTT trend as they leverage their IP.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.