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Netflix takes cash-fuelled road to streaming dominance

Its unorthodox media model is to spend big now on content and reap a massive subscriber base (and big profits) later

Mr Hastings has acknowledged that Netflix will have to compete against all kinds of subscription services.

New York

HERE are some notable numbers from Netflix:

  • 130 million paying customers as at September
  • US$14.9 billion in revenue in the last 12 months
  • US$1.3 billion in profit for the same period
  • 7.6 million more paid subscribers expected to be added in the last three months of 2018
  • 23 Emmy awards this year, the same as HBO.

Here is yet another notable number: US$18.6 billion.

That is the amount that Netflix has committed to spending on content, including many shows that will not show up on the service for months or even more than a year, such as new seasons of The Crown and Stranger Things and the much-anticipated line-up from the super producer Shonda Rhimes.

It is also far more than what traditional players such as the Walt Disney Co, HBO or NBCUniversal generally spend on entertainment.

But that is why investors are mad for Netflix. They are betting on its unorthodox media model: Spend big now and reap a massive subscriber base (and big profits) later. Possibly much later. The service's current tally of 130 million customers beat Wall Street estimates, but investors are ultimately counting on 300 million, or more.

The size of that number explains why Netflix is valued so highly relative to other entertainment businesses. The company's market capitalisation currently stands at approximately US$156 billion. Disney, by comparison, is valued at about US$174 billion.

Those figures look out of whack when comparing the size of the companies. Netflix had US$14.9 billion in revenue and US$1.3 billion in profit for the last 12 months. Disney generated US$58 billion in revenue and US$10.1 billion in profit for the 12 months ending June 30. (Disney will not report results for its most recent quarter until Nov 8.) In other words, Disney made eight times more money than Netflix, but it is only worth about 12 per cent more. Another way to consider it: Netflix investors are paying about US$120 for every US$1 of profit that it generates. For Disney, investors are paying about US$17.

Netflix is the streaming pioneer, but it is about to get some serious competition. Disney, led by Robert Iger, has already introduced a streaming sports service, ESPN+, and will introduce an entertainment offering next year. The company also spent US$71.3 billion for most of Rupert Murdoch's media empire, including the 20th Century Fox movie and television studios, a set of cable networks and - critically - a controlling stake in the streaming service Hulu. Disney will soon be able to sell access to films such as Black Panther,Avatar, and the original Star Wars trilogy directly to home viewers without having to go through Netflix.

Netflix is also part of the reason that AT&T spent US$85.4 billion for Time Warner - renamed WarnerMedia - which will unveil a new streaming service built around HBO by the end of next year. Those astronomical deals put Netflix's US$18.6 billion content spend in a slightly different light.

"There are so many competitors," Reed Hastings, Netflix's chief executive, quipped on an earnings call on Tuesday. "Disney's going to enter. AT&T is going to expand HBO. YouTube is on fire. And there's video gaming like Fortnight. There are so many ways to have great entertainment on the screen."

Mr Hastings acknowledged that Netflix eventually will have to compete against all kinds of subscription services, but "it seems very far off from everything we've seen". He added that as more media companies start selling directly to consumers, traditional TV networks will have to focus on news and sports to thrive.

New Fox, the broadcast business that will remain with Mr Murdoch after the Disney deal closes, has bet on sports programming such as Thursday Night Football and local news. Mr Hastings called that "a great strategy" since that type of content is "more resistant to the rise of the Internet". (Mr Murdoch will also retain cable network Fox News.)

Netflix's appetite for content means that it has to spend big, resulting in what is known as "negative free cash flow". More money is going out the door than coming in, a difference that Netflix covers by borrowing even more.

But Netflix can also show a profit because accounting rules allow entertainment companies to record most of its production or licensing costs later on.

A show like Stranger Things, entirely funded and owned by Netflix, costs as much as US$8 million per episode. Netflix pays for all of that up front, but the cost is not counted until the show is available on the service, often a year or more after production. The next season is expected to be released in the summer of 2019.

Multiply that by the hundreds of hours of original content that Netflix produces every year, and the cash starts to bleed out. The company had negative free cash flow of US$2 billion last year. It expects that figure to rise to about US$3 billion this year and about the same next year.

For Netflix, it is all part of the plan. An aggressive content strategy fuels a successful marketing strategy that leads to more subscribers. (There is also mounting debt.) Promoting House of Cards, now in its final season, was "really about selling Netflix", Ted Sarandos, the chief content officer, said on the call. "It's getting people excited about seeing something they can only see on Netflix."

The "you can only see it on Netflix" model has also fuelled the creation of competitors' services. That could lead to a content cold war in which studios discontinue licensing shows and films to other outlets in favour of their own streaming services. NYTIMES

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