The corporate narrative on Netflix has always been big drama. Is the streaming service a savvy disruptor that will live on forever as a pioneer of online entertainment? Or is it a house of cards promoting an unsustainable business model that all of Hollywood has been foolishly following?
Over the past few months, investors have tilted toward a more sober view of Netflix’s prospects. The stock price has nearly halved in that time, falling from $700 to $366, wiping out a $150 billion market value. At its peak in October, Netflix was trading at multiples of more than 10 times trailing earnings, well above its peers in media like Disney. Now it’s down to 5.6 times.
Normally, Netflix’s competitors would enjoy it malicious joy. Hollywood executives have long fretted over the company’s magical ability to lose money and increase market value. But instead, the selloff was troubling because all of these companies have copied the Netflix model.
After several years of watching Wall Street cheer Netflix, Disney, Warner, and other media giants announced big plans in 2019 to develop their own streaming services. Their share prices benefited. Their CEOs got their bonuses. Everything was good.
The problem is that the long-term business case for streaming is still being tested. The precursor to streaming, cable TV, is expensive, inflexible, and inconvenient for consumers — which is one of the reasons it made big bucks and generated revenue for studios. People could cancel their cable TV packages, but it wasn’t easy and there weren’t many alternatives.
Netflix broke the dam and grew rapidly in the process. At the time, it was too early to know if Netflix would become sustainably profitable, and if so, how profitable. Almost a decade after Netflix got into Hollywood, it began producing its own content house of cardswe get a clearer picture.
In the early days of Netflix, getting subscribers was easy, but lately it’s become a nuisance in the US. Last week, Netflix stock had its worst day in a decade after reporting subscriber numbers that failed to please Wall Street.
But Netflix have to continue to attract a huge number of new customers to be a good business?
Netflix supporters have argued that adding more subscribers would skyrocket revenue while stabilizing costs as it builds its content library. Making 100 new TV shows for your 200 million subscribers is better than making the same 100 shows for 100 million subscribers. As it gained weight, Netflix was also able to raise prices, allowing for even greater revenue.
In practice it was more complicated. After being fed all this television at a low price, viewers have become hungrier, stingier and impatient. I recently signed up for a free trial of Showtime so I can watch it Yellow jackets, a TV show my friends watched. I consumed everything in one weekend and then canceled the free trial without paying Showtime anything. why would not I?
“The expiration rate of streaming content is incredibly fast. squid game? That’s so last quarter,” wrote Michael Nathanson, a top media analyst, last week. “The business model is much more capital intensive than most other models we’ve seen.”
So even with 222 million subscribers, Netflix still has to spend a lot to keep us satisfied. Last year, Netflix reported negative free cash flow — the money left over after paying for operating expenses and capital expenditures — of $159 million on $30 billion in revenue.
MoffettNathanson predicts that Netflix’s revenue will grow 13 percent to more than $33 billion through 2022, but its spending will grow 15 percent to $27 billion (including $20 billion for content). That translates to $5 billion in net income, down about 3 percent from 2021.
So Netflix makes a lot of revenue but a lot less cash flow profit because its costs are high. In that sense, Netflix’s long-term business could look more like a telecom company than a tech company. The largest US telcos must invest heavily to offer the best service while keeping prices low because they sell virtually the same product as their competitors. Netflix was in a category of its own for a while. Now it’s surrounded by competition.
The stock market has spent the last decade rewarding Netflix for its vision and growth. This has long angered old studio executives. But what Netflix’s results have recently shown us is something fundamentally more scary for Hollywood: Streaming TV will make less money — maybe a lot less money — for entertainment companies than cable.
“You’re replacing a great model with a not-so-great model,” says Nathanson. “By a mile.”