Quick Thoughts: Netflix – Running Just as Fast as they Can


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–          Netflix quarterly beat was not enough – increasing programming costs and a reminder that a lot of people will watch the Olympics rather than Netflix for a few weeks slammed the stock.

–          The rising fees for the studio libraries that remain the lifeblood of Netflix are a reminder that exclusive content deals come with an ever increasing premium.

–          Netflix is following the HBO playbook – use library content to build a subscriber base, then establish original content to hold the beachhead once competition arrives.

–          If Netflix can build an enthusiastic audience for its originals, studio leverage and competition become much less important issues, but the question is “if”.


Netflix was on target with revenue and beat earnings expectations yet was slammed in after hours trading down nearly 15%. While the company reported domestic subscribers up 7.7% YoY driven by a growing streaming customer base, its increasing content costs are becoming painfully apparent with subscription cost of revenue up 36.3% YoY and squeezing profits. Netflix has several deals for exclusive content with Paramount and Lionsgate’s EPIX as well as the Weinstein Company which typically carry a premium to comparable non-exclusive content of 1.5x or more. With Amazon, Comcast and others looking to elbow their way into the online streaming movie market, and with Apple looking hungry on the sidelines, investors are justly worried whether Netflix keep the lead in the next stage of the race.

HBO faced a similar circumstance early in its own history, when it too relied on studio movie libraries to fill its schedule.  Of course, HBO went on to develop its own critically acclaimed content, which became its calling card with subscribers.  Netflix is making the same gambit.  With original productions like “Lilyhammer,” “House of Cards,” and the upcoming newly rebooted season of “Arrested Development” Netflix is betting it can establish a credible online TV network before the competition gets its act together. It is a particularly risky and expensive investment given the hit or miss nature of content. Then again, Netflix doesn’t care about Nielsen ratings or box office performance if it can keep its subscribers happy and their rolls growing.  It has the cash flows to fund its programming ambitions, and if it can gain loyalty and cost leverage, it will have been money well spent.

So far, so good. CEO Reed Hastings’ disclosure via Facebook that the company logged 1 billion hours in viewership in June affirmed tremendous growth in monthly streaming eyeballs up nearly 50% from Q4 2011.  No further details were disclosed in the earnings release, but that 1 billion hour figure represents almost a quarter of all US online viewing. Netflix will face significant headwinds to keep content costs down, despite currently having the strongest content catalogue of all the online content players. While Q3 guidance cops to the reality that viewership will wane during the Olympics, I’m not put off by the triggers that are taking the stock down tonight.  The real question is whether the new Netflix programming will get traction, and on that, the quarterly numbers give us no guidance.

For our full research notes, please visit our published research site.


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