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The Future Of Streaming And The Potential Downfall Of Netflix

|Includes: DIS, Netflix, Inc. (NFLX)

Summary

Netflix has reported negative cash outflows since June 2014.

Netflix’s cost of revenue is only expected to increase with increased competition for licensing rights to popular shows, and as Netflix becomes increasingly reliant on original content.

Disney’s DTC streaming service set to launch in 2019 has the potential to revolutionize the streaming industry with hours of Disney content and original series.

Other media giants may follow in Disney's footsteps, resulting in increased dispersion across the industry.

NETFLIX IN THE STREAMING SPACE

Cable TV is no longer the primary means of consumption – consumer preferences are changing, and the role of streaming services in the everyday lives of individuals is continuing to evolve.

The main competitors in the streaming space include Netflix, Hulu, Amazon, and HBO among others. Netflix has been a leader in the streaming services space since its founding in 1997 and has revolutionized the way in which individuals digest content. Ten years ago, people would sit around the TV on weeknights as individual episodes of their favorite shows aired. Today, consumers binge watch their television, enjoying “Netflix and Chill” sessions where they have the ability to watch three seasons of a show in a mere three days.

Previously, Netflix’s business models was categorized by its collection of shows available for reruns. IN more recent years, Netflix has increasingly incorporated its own content onto the platform including shows such as Stranger Things, Orange is the New Black, Fuller House, etc. Netflix recognizes a need to compete with other streaming services, and in order to avoid competing over the rights to different shows Netflix has instead turned to the creation of its own content.

INTERNAL ANALYSIS OF NETFLIX

Despite Netflix’s continued expansion, adding about 851,000 subscribers in the third quarter of 2017, compared to 368,000 for the third quarter of 2016, Netflix’s subscriber growth is expected to experience declines as the industry shifts from consolidation of shows on platforms such as Netflix to somewhat of an industry separated by content creators. The shift will likely become apparent with the launch of Disney’s streaming service in 2019.

Netflix’s recent subscriber growth has primarily resulted from an increase in international members. In addition, an increase in its subscription fees has likely been a main contributor to the observed increase in Netflix’s revenue per subscriber to $8.39 for the first three quarters in 2017 from $7.70 for the same period in 2016. It makes sense that Netflix increased its cost of membership, as the cost of revenues YTD for 2017 have increased by 42% to $870 million. Increased competition for Netflix in the industry has been a main contributor to the rise in its cost of revenues, as high-quality content becomes more competitive to bring onto the platform. Netflix will need to increasingly rely on its own content to retain subscribers.

Creating its own high-quality content and competing for the rights to popular shows is costly. Netflix’s operating cash flows have been negative since June 2014. Operating cash flows for the nine months ended September 30, 2017 of -$1.3 billion represent a 42% decrease in overall operating cash flows compared to 2016. As previously mentioned, cost of revenues, and therefore operating cash outflows, are expected to rise with increased competition and increased reliance on Netflix-developed content. The primary use of cash for Netflix is for the acquisition, licensing, and production of content. An important note is that these expenses related to the production of its own content do not explicitly appear on the income statement, as Netflix capitalizes costs associated with the production of its own content (i.e., development cost, direct costs, and production overhead). These costs are included in the account titled “Non-current content assets, net.”

FUTURE INFLUENCE OF DISNEY ON NETFLIX AND OTHER STREAMING SERVICES

Netflix’s original content will remain a key driver of future income in the currently evolving streaming space, especially with Disney pulling its content from the Netflix platform in 2019 and producing a Disney-branded direct to consumer streaming platform to showcase its content. In early November, Disney’s CEO Bob Iger provided additional details about its streaming initiatives. Its Disney branded service will provide subscribers with the ability to stream Disney, Pixar, Marvel, and Star Wars feature films in addition to new original series developed for the service including a Star Wars live-action series, a series based on the Pixar Monsters franchise, a High School Musical series, and a series from Marvel Television. Overall, the service is expected to provide users with thousands of hours of Disney film and TV library content.

With the largest media conglomerate entering the space, it is clear that Disney will become a major competitor to Netflix. Disney is leveraging its original content to revolutionize the industry. Netflix, Hulu, etc. have benefited from the combination of original content and the streaming of content it has brought to the service through payment for the shows’ and movies’ rights. Should other networks follow Disney’s lead and remove their content from services like Netflix, not only will subscriptions services deriving a large portion of their content from other companies risk losing subscribers, but also consumers will be forced to pick which services they choose to subscribe to. Although Netflix currently encompasses a large portion of relevant shows and movies, the potential dispersion of content across numerous streaming platforms could push consumers away from Netflix.