Why The 'Friends' Deal Is A Win For Netflix, Not AT&T

About: Netflix, Inc. (NFLX), Includes: DIS, T
by: Kevin Parker

Netflix reportedly will have "Friends" for another year at a price tag of $100 million for the year.

This deal showcases Netflix's tremendous ability to acquire content due to its large subscriber base.

From the AT&T perspective, it's another example of the difficult decision studios and rights holders will have to make regarding licensing their content.

As I read the commentary around the recent announcement that Netflix (NASDAQ:NFLX) will continue to license the '90s sitcom series, Friends, at an increased rate of $100 million for 2019, most of the response seems to center around applauding AT&T (NYSE:T) for collecting the $100 million. I couldn't disagree more with this viewpoint.

In contrast, I believe this deal showcases the strength of Netflix and the interesting predicament that studios, networks and rights holders will find themselves in as they straddle existing business models and pursuing a future in streaming. There are four reasons why I hold this position:

1. Netflix is in a position of strength, and it's only going to get stronger

Netflix bears love to cite the negative cash flow (which is certainly something to monitor in coming years), but they often fail to acknowledge the growing cash-generating business that Netflix is building. As Netflix approaches 140 million subscribers, it's building a massive pipeline of cash that it continues to reinvest into content.

Yes, it's also tapping the debt markets, because management views the opportunity to be so large that the wise course of action is to aggressively pursue growth and widen its dominant position. Management is focused on the long game and pursuing a position of dominance in the next era of global entertainment.

The Friends deal is yet another example of Netflix exercising its strength. In a time when content creators are attempting to withdraw their content from platforms such as Netflix in order to protect their own long-term future, Netflix has the ability to pay more for content than anyone else.

Increasing the price paid of Friends from a reported $30 million each year to $100 million for 2019 is acceptable for Netflix for two reasons primarily:

  1. Netflix can amortize content costs over a larger paid customer base than anyone else. While investors might view Netflix as overpaying for content, if you look at it from a cost per user perspective, the reality might be that Netflix is paying less for content than its competitors.
  2. Netflix has better data than anyone else. Only Netflix knows how valuable Friends is to it. Clearly, it views the value as more than $100 million.

The above two reasons why this deal makes sense for Netflix are more important to the macro picture and the long game than anything else being discussed.

2. Yes, content is king. And who is creating the most content?

Netflix bears are quick to note that this deal demonstrates the value of franchises such as Friends. I agree!

And who is investing more into original content than anyone right now? That's right, it's Netflix.

Again, Netflix is focused on the long game. While Netflix has the ability to license content such as Friends today, the company is simultaneously focused on creating the Friends for the next generation. This is precisely why Netflix has made some of the biggest deals in the industry acquiring show creators such as Shonda Rhimes and Ryan Murphy.

3. Other studios and rights holders will find it difficult not to take Netflix's cash

AT&T and HBO executives are on record about how important it is to ensure that their to-be-launched streaming service is in the group of 4-5 streaming services that consumers view as must-subscribe services (a group that nobody denies Netflix is in, by the way).

Yet, companies such as AT&T and Disney (NYSE:DIS) are pursuing the future while simultaneously keeping an eye on and managing existing business models and cash flows. Note: I'm bullish on Disney and view it as the one company strong enough to escape the Netflix gravity field.

As Netflix's dominance increases, studios and rights holders will find it difficult not taking the next $100 million check. They have content, and not further monetizing it by taking Netflix's money will be challenging especially as legacy businesses decline. The simple reality for much of the entertainment landscape is that Netflix is 1) increasingly eroding its legacy businesses or 2) has too much of a lead on these would-be streaming platforms.

4. What matters is owning the demand

Netflix owns the demand, and this isn't changing. While select Disney brands might be outside the ecosystem, Netflix will continue to be in a position to create or license just about any content moving forward because of the power of its business which is the almost 140 million (and growing) paying subscribers.

The value of a $100 million check to AT&T is peanuts compared to the subscriber growth that Netflix delivers quarter after quarter. The stakes are so much bigger than a simple licensing fee. Netflix has been playing a different game than its competitors for years, and incredible companies like Disney only just realized it.

As long as paid Netflix subscriber growth continues, other companies will find it increasingly difficult competing with Netflix at the game that it is playing. Networks will become increasingly niche, or struggle to develop direct-to-consumer platforms while attempting to maintain existing traditional cash flows.

Netflix, meanwhile, is singularly focused on owning a relationship with the end user as the world shifts towards streaming entertainment. I'll continue to bet on Netflix.

Disclosure: I am/we are long NFLX. 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.