Netflix is the big kahuna of streaming subscriptions. A tech and movie colossus streets ahead of all current and potential competitors. It definitely has the wind behind its sails, indeed it feels like it sets its own weather. But like everyone Netflix too has plenty of risks ahead and pitfalls to navigate if it is to remain top dog. Here are a few that come to mind:
1. Debt and cash burn
As you’ll be aware, Netlix spends big, very big, for new film and TV productions. A couple of years ago it was around $8 billion annually. Last year it reached $12 billion and will probably pass $15 billion this year. Netflix is profitable, $1.6 billion last year, but that’s a long way off paying for all that new stuff.
Netflix fills the gap with debt. Lots of it. By the end of last year its long-term debt had reached over $10 billion, a 90% increase over the last two years. By comparison the company’s revenue rose 79% over the same period. All this means that Netflix’s cash burn, the difference between actual money coming in and what it pays out, is huge. This negative cash flow reached over $2.6 billion last year, up from $1.7 billion in 2017. It’s only the money it raises through debt that allows it to keep on funding this.
None of which is to suggest Netflix is in any imminent financial trouble. While it continues to add subscribers and expand its revenue around the world the company’s investors are pretty happy with the way things are right now.
But that doesn’t mean there isn’t risk here. At the end of last year, Netflix had just under $4 billion of cash on hand. That’s not nothing, but not enough on its own to keep up spending at its current pace either. It will need to raise more debt in due course. Debt can carry a business a long way but things can and do change and the debt markets can shut down very rapidly. The last recession was over 10 years ago which means historically we are now overdue the next one.
In that last recession, the debt markets completely seized up. That was one of the reasons the acquisition of my former employer, EMI, by Terra Firma, in 2007, went so spectacularly wrong. The Terras had always assumed that they would be able to refinance their acquisition with new debt as that’s what they’d always been able to do before. The great credit freeze of 2007, a shock that struck just a couple of weeks after they’d agreed to buy the company, meant they suddenly couldn’t any more and they were stuck with a debt pile they could no longer afford. They ended up losing all their investment and ownership of EMI to their bank.
Ultimately over the long term, for any business, just like individuals, cash is king. If you can’t raise debt but you have enough cash, you’ll be ok, while the reverse can tip you over the edge. And you can never predict when the debt markets will turn against you, as Terra Firma found to their cost. In the world of debt, timing can be everything, as the tale of Amazon perfectly illustrates.
In hindsight, the moment that the first dot com crash began was the peak of the NASDAQ stock exchange on March 10 2000. Two weeks later, Barron’s magazine featured a cover article saying ‘Burning Up: Warning: Internet companies are running out of cash—fast’. Shortly afterwards, in a single week in April, the NASDAQ plunged 25%. The good times were well and truly over and the debt markets slammed abruptly shut for all dot coms. Many formerly super high flyers of tech did indeed completely run out of cash and had to shut down. But not Amazon.
Amazon had managed to complete a successful bond offering of nearly $700 million in February 2000 - less than a month before the dot com crash which helped ensure they had enough cash to see them through the coming debt winter. If Amazon had delayed only a few more weeks they wouldn’t have been able to raise anything and many things in our tech and media world would likely be very different.
As well as things like its ambition, speed of execution, discipline, etc, it’s wise to remember that Amazon is also frequently a very lucky company. As one of the greatest strategic thinkers in history, Napoleon, famously said, “I'd rather have lucky generals than good ones.”
So far Netflix too has been a lucky company. Building a market leading position globally in a benign competitive environment and with supportive financial markets. The next time the debt markets turn less forgiving however, as they will, we’ll find out just how lucky they really are.
2. Amazon
Speaking of Amazon, they too have been investing huge amounts in long form video, all under the umbrella of Prime Video, but to date the offering has been very dispersed and varied. Some content is included as part of Prime membership, more isn’t but is available to rent or buy, while some can only be accessed through partner channels or services.
It’s not very consistent and you almost get the feeling that Amazon almost haven’t quite determined that they want to take on Netflix directly. Yet. Because if they do, Netflix will really feel the heat.
And of course there’s also Amazon’s still significant lead in voice. Voice and TVs haven’t really come together yet, but if and when they do, Amazon will be very tough to beat.
3. Disney
If Amazon haven’t quite decided whether they want to go head-to-head with Netflix, Disney sure have. They’ve been preparing the ground for it for some time, making their plans and getting their assets in place. Netflix of course know this. While Disney has been ending its licensing with Netflix, Netflix have returned the favour by cancelling a number of Marvel shows in development.
While Amazon is still in the category of potential major competitor, with the impeding launch of their subscription service, Disney have moved squarely into the position of actual competitor. And they are without question the strongest. Lest we forget, Disney has taken all the traditional Disney content, still the most powerful family and kids brand, and in plain sight of every other media and entertainment player, added to it such powerhouse assets as Pixar, Marvel and Star Wars. And that’s not counting all the riches in other brands, assets and platforms they have.
Disney is the first full on battle Netflix have had to face since they vanquished the would-have-died-anyway Blockbuster.
4. Many Netflix Originals are still licensed in, not owned
To Netflix’s credit they knew very early on that at least some of the Hollywood studios would one day shift from licensee partners to fully fledged direct competitors. It was preparing for this that led to Netflix spending all those billions in the original production business in the first place. Starting with House of Cards, Orange is the New Black and so forth, their Originals slate is now a huge driver of their continuing growth.
However, to date most of these Originals have not been developed or produced by Netflix. Somebody else does that, frequently one of the big studios themselves. Netflix didn’t develop or produce House of Cards for example. They just wrote a large cheque for the rights to show it exclusively. That was without question a good deal, but to date the vast majority of programming labelled as a ‘Netflix Original’ has been bought in, which means Netflix’s rights are limited, either geographically, for a certain period of time, or both. And in many instances they will have to renegotiate and pay again to extend the license when the term is up.
They are working hard to change this, developing and producing their own output from scratch so they don’t need to license them from anyone, they’ll own it themselves. That is the traditional model of the Hollywood studios themselves so it’s not a new idea and definitely not a bad one. But those kind of productions, the ones owned and controlled outright forever by Netflix are still the minority of Netflix Originals which means they’ll have to continue to shell out massive license fees for some time to continue showing plenty of stuff Netflix launched and grew to success in the first place.
5. What happens when subscriber growth slows?
Netflix now has almost 150 million subscribers worldwide and is still adding them at a record pace, but obviously it has to hit a ceiling at some point. And nobody has any idea what that is. Numbers ranging from 200 million to a billion have been put out there.
Whatever it is, that ceiling will be reached one day and then what? Netflix, a lucky company so far don’t forget, has been able to grow financially both by adding new subscribers and by raising prices (the second lever one not available for all its streaming media peers).
But once the new subscriber wave peters out, then growth is about the much tougher grind of pushing up ARPU (Average Revenue Per User) and grabbing subscribers from the competition. Very much like the mobile phone companies in the rich world now that everyone has one.
In that environment it’s a lot harder to maintain double digit growth. Personally, I still think the genre and specialist route doesn’t get nearly enough attention as the way to keep the good times going for longer.
6. Just how many subscription services will the market bear?
Related to that, what is the sustainable number of subscription services in the streaming market? Not just on long form video, but music, games, news, etc. While they may be distinct offerings, paying for all of these comes out of the same consumer budgets.
As more and more players pile in, how many services will most consumers be prepared to pay for? And as the landscape becomes more competitive, just how loyal will subscribers be?
Because they are a general as opposed to specialist platform, Netflix have to constantly appeal with a never ending stream of new content. Hence those vast Originals budgets. But every creative business and individual knows that everyone has hot and cold streaks. Times when it seems everything you touch turns to gold, and other times when nothing goes right.
While Netflix have been largely the only game in town, customer retention hasn’t been a massive concern for them. But as the competitive landscape heats up, that will get a lot harder and we’ll find out how many profitable services can make it in the streaming market.
7. Advertising
Netflix is a purely subscription-funded service. Other than showcasing its own wares to its own subscribers, there’s no promotion or advertising of any kind. But most of the media and entertainment landscape isn’t and never has been like that. Advertising has always been a major revenue stream.
This is happening in streaming media as well. Spotify obviously have their ad-supported service running alongside their subscription one which has always been and continues to have more people using it than the paid for one.
In television Viacom, parent of the likes of MTV, Comedy Central, Nickelodeon and Paramount Pictures, recently bought internet television network Pluto TV which is exclusively funded by advertising. Meanwhile AT&T, now owners of WarnerMedia, are gearing up to launch their Netflix competitor under the HBO banner and have suggested that while it will be subscription-based first, advertising will definitely be part of the picture in due course.
Advertising gives companies both additional revenue and a way to reach consumers who aren’t prepared to shell out for a subscription. Neflix hasn’t had much problem dealing with either issue so far, but as more ad-driven rivals come on board and as consumers have more options that won’t require them to pay a direct subscription cost, will Netflix’s model continue to work?
As I say, to date Netflix has had the good fortune to be a lucky company, and successful entities always have a big hand in making their own luck anyway. I don’t expect that to change for Netflix any time soon, but nothing stays the same forever and it’s always good to have things to worry about. That’s the only way to keep you on your toes after all.