Netflix: Streaming Wars

Summary

• Category leader with COVID-19 tailwinds.
• Extraordinary management team with two decades of flawless execution.
• Huge growth opportunities by focusing on global expansion.
• Intense competition with every rising content costs.

Overview: Netflix is a streaming service that allows our customers to watch a wide variety of award-winning TV shows, movies, documentaries, and more on thousands of internet-connected devices. Netflix runs a subscription-based model for its streaming services. Netflix has been a blockbuster stock in the last 5 years as its market capitalization has increased by 461% to over 249 B.

Strengths:

Management Team

The Netflix management team is one of the top teams in Silicon Valley. The team has proved its strategic leadership by making Netflix a dominant player in the streaming space. Through their actions over the past decade, they have showcased a deep understanding of the streaming business which has helped give direction to the venture. Netflix is at this spot today because of a couple of huge decisions:

1. Moving away from DVDs to online streaming

2. Rapidly signing content to become a media giant

3. Creation of Netflix original content

These decisions have been key in Netflix’s success story as at each point the team was pushed into a corner and they picked the right choice. The best example is when Netflix started creating original content in 2017 when third party content creators(big production houses) started putting massive price pressure on the company. I’m really pleased with Netflix’s decision of making Ted Sarandos Co-CEO along with Reed Hastings. This is important as Netflix has now become a content business more than anything and putting their Chief Content Officer in a broader leadership role shows recognition for the same.

Massive Subscriber Growth

Netflix added 37 million subscribers in 2020, which has a growth rate of more than 22% percent year over year. Netflix now has 204 million subscribers worldwide. Netflix has maintained solid growth since 2010 but it’s been accelerated due to the COVID-19 pandemic. Key tailwinds in consumer trends that will increase overall demand in the long term:

• Individuals will spend more time at home due to Increased remote teams, lack of activities because of the pandemic.

• Expenditure previously allocated for entertainment will be directed towards digital experiences, putting Netflix in the front seat to absorb this newly allocated capital.

• With individuals moving outside of major cities individuals will spend more time watching shows and movies they love.

Along with that Netflix overall has huge growth opportunities. Netflix has a lot of untapped potential in terms of new markets it can tap like India, United Kingdom, and other incredibly huge markets.

Fun facts around Netflix’s dominance:

• Netflix took up 72 percent of the streaming time in homes, according to a new research report from Moffett Nathanson in partnership with HarrisX.

• Netflix entered the 2020 Oscars ceremony with 24 nominations on its scorecard -- more than any other studio. At the end of the night, it walked away with two wins.

Financial Performance

Netflix’s growth has translated into solid financial results.

Key highlights:

• Strong revenue growth averaging over 30% and operating income growth rate averaging over 74% showing margin expansion.

• Overall dominance over VoD has helped Netflix increase prices for almost all their plans. Another price high is expected in 2020 considering the increase in content usage. This is especially powerful for a company like Netflix which charges its customers a subscription on a monthly basis. In 2020, an increase in $1 could increase its overall revenue and net income by $195 M on a monthly basis.

Content first strategy

Netflix is one of the first streaming services to recognize that this is now a content race more than anything. The most important thing to acquire and maintain customers is quality and quantity of content. Netflix plans to spend $17.3 billion on content in 2020, according to a new forecast by Dan Salmon, an analyst with BMO Capital Markets. By 2028, the analyst firm predicts, Netflix will spend $26 billion per year on content. Netflix is a very strong business but I’m is a viable investment only in the short term. The reason is that as Aswath Damodaran said Netflix has started this endless cycle of raising money to create content which leads to more users and hence more revenues. Then they use these revenues to repay past loans and acquire more debt. Hence in the long term, it is very difficult for Netflix to break this cycle and in turn unsure about its future.

Risks

Intense Competition

The streaming business has become highly crowded in the last couple of years. Companies like Apple, Disney, and many others have recently entered with plans of expanding their reach. I believe that this is a huge risk as it puts pressure on Netflix in terms of overall customer acquisition, and finalizing third-party and original content. The current competitive landscape has definitely changed the pricing dynamics for popular content. Examples: Starting Jan. 1, 2021, all nine seasons of The Office will move to NBCUniversal's new streaming platform, Peacock; Netflix acquired the streaming rights to Friends in 2015 in a $100 million deal and, according to Nielsen, it is the platform’s second-most streamed show; In July, however, WarnerMedia, which owns HBO, outbid Netflix to secure the show’s streaming rights in a whopping $500 million deal. After losing Friends, in another $500 million deal, Netflix acquired Seinfeld’s streaming rights in September to take its place, but fans of Jerry, Kramer, and Elaine won’t be able to stream all 180 episodes until 2021.

Overall cost of content: Third-party and original

The overall cost of content has skyrocketed since early 2016. This is primarily due to the overall competition intensifying. This is a risk as Netflix is still in the process of creating a portfolio of original content so has a high dependence on third-party content for now. Huge number of users come to Netflix because they have classic shows like Suits, Friends, etc. Netflix management is making significant efforts to regain license contracts.