Netflix (NASDAQ:NFLX) is getting way worse of a rap than they deserve given the way they control costs, their business history and their positioning relative to peers in the entertainment industry. Their lean production model is rare in aworld dominated by big studios, but it's produced some absolutely stellar results and underscores their commitment to keeping expenses under control, a virtue heavily underappreciated these days. They've weathered economic downturn and competitive upheaval before, surviving the 2008 recession and coming out of it an absolute juggernaut while embracing streaming media alongside their groundbreaking DVDs-by-mail service until it became clear optical media was no longeren vogue.
The jaw-dropping crash from the high of November 2021 is as much a return to fair valuation as anything. The market got so far out ahead of itself, with FAANG at the forefront, that any large-scale pullback such as that currently in progress would be the skimming of the froth and an opportunity for analysts to drop price targets without needing to admit they had gotten caught up in the exuberance. While Netflix is certainly not a "value name", it's handling the current market turbulence fairly well after a few quarters of pain, and their financials look solid enough to endure a downturn and come back roaring once again.
Costs And Content
If there's one constant in business and life, it's that a dollar in savings is worth more than a dollar in revenue. When it comes to budgeting for content, Netflix goes full shoestring budgets almost every time, but they and a good portion of their competition know when to double down on their tentpoles.The Crown and Stranger Things season 3 have production budgets of about $10 million an episode, butStranger Things 4reportedly cost almost $30 million an episode. Paramount (PARA) has thrown a decent amount of money at Taylor Sheridan's works, with hisYellowstoneprequel series1883doubling the$6-8 million price per episodequoted for his typical shows. HBO (WBD) let their production costs forGame of Thronesgrow all the way up to $15 million an episode in the final season, before striving to keep costs forHouse of the Dragonunder $20 million an episode, a savings they credit to increased efficiency after working on previous shows.
Compare these far-and-wide content seedings to Disney (DIS), who will drop $25 million an episode on Marvel shows likeWandaVision,orThe Mandalorianat $15 million an episode; or Amazon, who is shattering records for their costs onThe Rings of Power, with the first season costing nearly $60 million an episode and arumored nearly $1 billion in total being committedto the show so far. Blockbuster budgets may have made sense in the era of linear TV and movie theater releases, but the streaming era has proven that lean-and-mean is a viable option too.
Running lean on production costs also has a side benefit of allowing for a much broader slate of content compared to a "Friday night lineup" style programming schedule that linear TV follows. Friends of ours mentioned a favorite Netflix show for their kids wasDinoTrux, a show with such a bizarre premise - dinosaur-themed heavy machinery - that it makes you wonder if it wouldeverstand a chance in the stable of studios like Disney, Nickelodeon or Cartoon Network (the fact that the show is produced by DreamWorks notwithstanding). A recent Netflix launch, the animated showOddballs, was written and developed by YouTuber James "TheOdd1sOut" Rollins, and hediscussed the experienceon his YouTube channel. One piece he mentioned about his experience pitching the show stood out to us regarding the feedback he got from the first executive to whom he pitched:
...the executive told me that no studio would ever want to work with a YouTuber… So, you know, not the best confidence boost ever for your first pitch.
Playing deductions here: James worked with industry veteranEthan Banville, whose credits include a number of Nickelodeon shows. It would make sense that they pitched to Nickelodeon first and, consequently, that Nickelodeon executives were the ones who made this rather blanket comment about the industry. Netflix saw it differently, apparently, tapping into an established fan base with proven merchandising power to strengthen their animated offerings.
Appealing to a niche audience is the given, but it's when a show goes viral that this modeltrulyshines. Case in point:Squid Game. A Korean dramawritten ten years ago and largely forgotten, picked up by Netflix and produced for about $21.4 million, became synonymous with pandemic life and embodied the zeitgeist in many folks' minds. Netflix also believes very firmly in letting their non-US content reflect native culture as authentically as possible, which made production smoother and even added to the charm of the show to its international audience; contrast Disney's checkered track record of US-centrism in works such asPocahontasand the live-action remake of Mulan.
Netflix also has the advantage of not being beholden to a behemoth of a business with a reputation to uphold. Disney has thrown their weight around on political issues a time or two, especially recently, and Apple has a pattern of using their content as a soapbox to push agendas. Look no further than Tim Cook's comments on Apple's earnings calls saying that the goal of Apple TV+ is to "give creators a voice".Quantifying The Business Of Content
When compared to the purest-play competitors in streaming - Disney, Warner Bros. Discovery and Paramount - Netflix's financials have truly shone over the last five years. Their TTM margins have outperformed the other three with considerably less volatility than names like Warner Bros.
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Of the major Communications companies with significant exposure to streaming (who at least break out their video production costs on their financial statements - looking at you, Apple), there's a pretty sharp divide between the businesses for whom content is their main business and not. Three names - Netflix, Disney and WBD - carry over $30B in content-related assets, mostly capitalized costs of production to be amortized, on their balance sheets. The others - Paramount, Comcast (CMCSA) and Amazon (AMZN) - have somewhere between $10-15B in content-related assets on their balance sheets.
The difficult part of assessing the competitive landscape is the heavy usage of non-GAAP metrics, by both studios and analysts, as a measure of size and health. For Netflix, that number has always been subscriber count, and the simultaneous decline of their own numbers and increase of competitors' numbers has sounded the biggest alarm. They have responded to this issue by stating their commitment to improving value for their subscribers instead of aggressively seeking out new subscribers. This pivot makes sense, given that smash hits are not creating massive spikes in new subscribers like they may have back in 2013 when original content was… well, original.Squid Gameonly netted 70,000 new subscribers in North America against an existing nine-figure subscriber base, at a time when people were ripe for binge watching streaming services.
Risks Cannibalism And Competition
Streaming is hot business now, every studio knows this, and the fight is starting to heat up. Just this week, Nielsenreportedfour different streaming platforms had a program with over a billion minutes watched. Streaming rights and revenues are no longer taken for granted, just look at the Disney mess withBlack Widowor Paramount's doubling down on successful creators (Sheridan and South Park creator Trey Parker) with home-grown content to seed Paramount+ while their flagship shows stream on competing platforms (Peacock and HBO, respectively). Netflix may have the inside track, but they are the only name in the streaming space that doesn't have any sort of alternative revenue stream to cushion the costs of content production (even WBD has some in-house games they've developed based on their IP). Hence the push for anad-supported tier. Since streaming rights to other studios' content are effectively off-limits, it's more important than ever to provide budget-friendly access to your own content in order to prevent consumers from canceling outright.
Meanwhile, Netflix's subscriber count is starting to shrink, and they've finally acknowledged that practices such as password sharing are hurting their revenues. In the face of the challenging macroeconomic situation and the roaring inflation, belt-tightening is bound to happen, and streaming subscriptions may be high on the list to go. Don't be surprised if streaming services start agreeing to bundle deals with "channel stores" from names like Roku (ROKU) orYouTube(GOOG).
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