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MKArch (99.70)

The NFLX Dilemma

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March 19, 2011 – Comments (4) | RELATED TICKERS: NFLX

The news yesterday that NFLX is buying a tv program inspired me to post about them again. I don't just think they have a valuation problem I think their whole subscription based streaming model is unsustainable and IMHO the tv series is a desperate attempt by Hastings to try to address a fundamental flaw in their subscription model. How do you keep subs renewing over the long haul with nothing but old movies, tv reruns and when STARZ renews what ever new content STARZ bread and butter Cable customers don't care that NFLX gets. Take a look at the article below and imagine what happens to NFLX model once they reach saturation with new subs. I see hordes of older subs walking because they've seen everything a dozen times already which will force NFLX to cut back on content to keep costs down in a death spiral.

http://seekingalpha.com/article/252310-the-netflix-churn-challenge

Comcast has about the same number of video subs ~23M as NFLX does right now. According to a recent 10Q they spend ~$7.4B/ year for programming. I think even after all the recent deals and factoring in the $200M-$300M estimated NFLX will pay for a STARZ renewal they will only pay ~$1B or so for content per year. Comcast pays ~7X what NFLX will pay because they want enough new content to keep subs renewing every year. To me the NFLX original program deal is a desperate attempt to address the problem of not having enough new content to keep subs for any length of time. Is one show going to solve the problem? If not how much original programming can they afford and how do they suddenly become a studio in addition to streaming content provider? Lightning struck once with a bone headed content deal on STARZ part, can it strike twice?

4 Comments – Post Your Own

#1) On March 19, 2011 at 1:36 PM, TMFBabo (100.00) wrote:

I don't agree with all the short arguments out there, but cost of content is the one I find pretty compelling.  As a Netflix subscriber, I can say that I love the choice I have (remember, we still get DVDs by mail too) for the price I pay.  Still, Netflix is going to have to pay up for content in the future and I'm waiting to see if increased subs plus incremental price increases are enough to balance it out. 

I'm pessimistic about the stock because the valuation is so high right now, but I would never in a million years short Netflix.  I'll just let my CAPS red thumb continue to get pummeled instead.  

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#2) On March 19, 2011 at 1:51 PM, MKArch (99.70) wrote:

I don't do shorts in real life because I definitely can't stay solvent as long as the market can stay irrational babo so this is just a CAPS red thumb for me as well. My understanding is NFLX wants to eliminate dvd shipments and has been trying to wind that segment down. Your argument that new dvd content along with streaming older content intuitively makes some sense but looking at the churn numbers in the article I linked it doesn't appear to be enough to keep subs for long and from what I understand NFLX wants to phase dvd's out eventually.

The article mentioned ~120M U.S. households but I think only 70M have broadband service. It looks like since 2002 they have signed up almost 50M subs. Some of them may be repeats but it looks like they are nearing saturation in the U.S. Canada's a tiny population and I think any other market is going to be a lot harder to break into with slower growth. I hear the arguments about a virtuous circle of growth leading to more content but when I look at the numbers of subs walking I see the opposite in their future once they hit the wall on new sub additions.

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#3) On March 19, 2011 at 2:32 PM, MKArch (99.70) wrote:

This is probably something I should have added to the original piece but IMHO adding their own content is in response to what they see coming down the road with their STARZ renewal negotiations. I think Comcast charges something like $15.00/ month for a STARZ subscription. Their programming cost work out to ~38% of their video revenues. Assuming 38% of the STARZ subscription fee is what Comcast pays to Starz that works out to ~$6.00/ month. That would wreck a model that charges $8.00/ month. Obviously NFLX can't afford to pay anywhere near what Comcast pays for STARZ content and STARZ CEO recently addressed this issue. he stated: "If NFLX wants cheap content they'll just get less of it". The $200M-$300M estimate of what NFLX will pay to renew with STARZ works out to ~$1.00/ sub/ month based on their current sub count. What kind of content do you think they get for that price?

I read articles suggesting the DIY content will enable them to better bargain with the content providers. IMHO it's a preemptive attempt to make up for an inevitable drop in newer content when they renew with STARZ. Is one series enough to keep subs coming back year after year? I don't think so.

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#4) On March 19, 2011 at 3:55 PM, amassafortune (29.99) wrote:

NFLX may be the poster child for business in the digital age. They were saavy enough to realize they could beat Blockbuster by leapfrogging the brick and mortar model, and they are moving quickly so as not to become the next technological dinosaur.

They created one of the most efficient physical distribution and order fulfillment structures in the world. One of their challenges will be how to profitably offload physical distribution,- maybe in as soon as two years, as downloads kill DVDs. They could take on fulfillment clients, spin off physical distribution, or just sell that part of the business. 

If I'm a studio, I'm already wondering why NFLX is needed as my middleman because I'm already sending them the product electronically. As a studio, I'd probably contract with NFLX to develop my capability to serve my customer directly within a few years. So, NFLX uses my servers, my workers, and my content for a few more years, but at some point I take on full ownership of the content-to-viewer stream. The studios are also looking forward to the day when any physical copy of their intellectual property will be a knock-off. Flea market parking will soon be easier.

NFLX, by buying production capacity, may be looking more at the education market than entertainment, long-term. Imagine high schools modeling colleges with alternating days of lecture and recitation. Teachers would still retain face-to-face lab and recitation duties, but much material can be delivered electronically. Savings could come in the form of alternating physical and digital schooldays, or by having digital classes monitored by non-accredited personnel.

Even NFLX may not have the insight, luck, and omnicience to survive another decade with the speed this segment is evolving/mutating. Alta Vista, Netscape, Yahoo, Twitter, Google, Facebook - we're in an age when some Fortune 100 companies may only last a decade. That reminds me, the Encarta CD-rom in my rack here can be tossed anytime.

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