FEBRUARY 4, 2019
There is a disturbing international trend that emerged from Netflix’s latest financials that has not been discussed widely by other commentators.
Until the last quarter in 2018, Netflix’s international revenue was growing faster than its paid membership. For example, in Q3 2018, international revenue increased by 48% year-over-year, while members grew by 39%.
However, during the last quarter of 2018, international revenue increased by 35%, yet membership grew by 40%. This is the exact scenario Netflix is desperately trying to avoid.
Netflix cannot afford for membership to outpace revenue. If this trend continues, the cost to provide content would outpace revenue growth, which is a death sentence for future international growth.
Unfortunately, there are multiple issues that are causing or can exacerbate this negative financial momentum; four of which are outlined below.
First, Netflix’s content obligations per subscriber are significantly higher than revenue per subscriber. Through 2018, Netflix’s obligations have increased from about $17 billion to over $19 billion.
With $19 billion in streaming content obligations and its $10.4 billion debt load (only $3.4 billion at the end of 2016), Netflix is digging a hole that is approaching $30 billion.
Second, Netflix must post substantial subscriber growth in the face of increased competition from Disney+, WarnerMedia, Hulu, and others.
Third, Netflix must cut its content spending growth rate by more than 30% annually over the next few years. Any cut to content spending will decrease the company’s only competitive advantage in content creation, namely the overpaying for development, production, and licensing.
Fourth, customers must be willing to accept the recent and future price hikes without Netflix witnessing significant runoff.
In addition to these issues, there are many more costs that Netflix must contain if the company plans to escape a situation whereby they lose money on each new subscriber they gain.
Last quarter, Netflix spent over $730 million on marketing, which increased by 56% annually. Netflix spends around $100 on average to acquire a subscriber. It currently spends $200 to acquire a U.S. subscribers versus $80 to land one international subscriber.
The company also spent over $330 million on technology and development, which was up more than 30% year-over-year.
Beyond overpaying for content development and production, Netflix has been overpaying for producers, software engineers, and content managers for years.
In some cases, Netflix will pay 2x to 3x industry averages to acquire workers. Netflix has also been accused and litigated for executive poaching.
To fund its debt obligations, Netflix spent $129 million on interest expense in the last quarter alone. This expense will only increase as Netflix continues to borrow to fund its expansion and as interest rates increase.
These three aforementioned expenses total $1.2 billion a quarter. Even at zero growth in these expenses, Netflix would spend almost $5 billion per year on these alone.
Looking to 2020, Netflix won’t be the darling of Wall Street with a potential $3 billion profit, being dragged down with $5 billion in expenses.
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It’s a mystery why anyone believes Netflix when they release viewership data about popular content such as Bird Box.
The non-audited viewership figures are not transparent in the least bit and only act to justify to its institutional investors and junk bondholders that the enormous sums overpaid for producing content is paying off.
The company’s selective transparency is a ruse to inflate the impact of its politically charged content and to hide the fact that most of the films it produces are not financially or creatively successful.
Netflix has long argued against releasing viewership data on the basis that the company does not sell advertising, but this secrecy goes much deeper. Only when Netflix releases complete viewership data can any of these “successes” be taken seriously.
Netflix is one of the substantial success stories in media history. In an age when the studios were too shortsighted to see the future value of streaming, Netflix built loyal subscribers using the studios’ own content. Once the studios woke up to launching stand-alone services, Netflix had already captured 140 million global subscribers.
The next two years will determine if the company can finally turn the corner into profitability and stave off growing competition from Disney, WarnerMedia, Amazon, and a host of homegrown challengers in international markets.