Is Netflix a threat? "It’s a little bit like, is the Albanian army going to take over the world?” "I don’t think so." Jeffery Bewkes, CEO Time Warner 2010
None of what I say should be considered as investment advice ( do your own work)
Netflix has gotten crushed since I wrote the thesis. . Summing up I think the dispersion of outcomes has increased and while I believe this is still a good company and a good long term opportunity (short term is bumpy) my confidence has decreased ( I don't like how the industry is evolving towards AVOD + more fragmentation).
We'll see
I hold a position
--- What Happened?---
The combination of COVID hangover (people travelling more and online shopping/streaming less) + macro + more saturated market than I expected has proved to be a lethal blow.
Netflix in the US is especially vulnerable to subscriber loss, as the subscriber base is far more penetrated. This led to the largest decline in net US subscribers in the past ten years; the upcoming months do no bode better and Netflix has guided towards subscriber losses over the next quarter. The subscriber base was more penetrated than I thought and the marginal subscribers are very price sensitive
Netflix, among others, has suggested a variety of contributing reasons for rising churn, including the price hike and increasing competition.
According to Ampere low household incomes are the ones who have churned the most ( that is why management thinks that AVOD makes sense). The reality is that the absolute levels of churn are way lower than in previous price hikes; however given that the subscriber base is more penetrated and gross adds are much lower that leads to higher net losses
Based on alt data Q2 looks even worse ( same dynamic and even higher levels of churn). On top of this we are looping a complete reopening of the economy, an increase in travel and inflationary economy which makes comparisons even worse
However there is very little that leads me to believe that the competitive position has deteriorated:
1. Ampere data: amongst US Netflix leavers in Q1 2022, most users had not signed up to another SVOD service in the 2 months prior to churn. Users who did stack services generally churn from Netflix less often. Only a very small percentage of US Netflix leavers switch to another SVOD service soon after churn, suggesting that churn in Q1 has not been predominantly competition-driven (7% of churned subs).
2. CTV Nielsen viewership data: Netflix has held its market share since 2021. However the fragmentation is increasing and the landscape is less concentrated ( more streaming services emerging).
--- My take/ conclusions ---
°Monetizing password is just an output, I will focus on inputs
°AVOD: I see why management feels pressured to release AVOD ( and channel checks seem to point that it would be revenue accretive). However AVOD decreases barriers of entry and makes the industry prone to aggregation ( you would need no scale anymore and channels like Google TV , or Fire could potentially aggregate fragmented inventory) = Increased uncertainty about the future business model
° Accounting/CF: if you adjust for non released content ( still in production or not released) the cash flow is quite close to the amortization expenses as the amortization is not linear ( it is frontloaded). Another output not an issue for me.
° Competition: audiences are fragmenting and everyone and their mother is eating into Netflix video hours ( Tik Tok, FB , SNAP publisher content etc) while there are only 24 hours per day.
I think there are 3 key questions
1.How do you come up with great content that people want to watch?
At the end of the day this is the key. This is the capital allocation business so how do you allocate capital more effectively?
Constellation software has taught us that the best way to allocate capital is to build a decentralized structure ( Less than 50 people greenlight content in Disney vs +400 in Netflix) YouTube would therefore be the best structure and Netflix is the closest you can get to YouTube in scripted content ( as content costs money and is not user generated; see my essay).
According to the former product innovation chief at Netflix:
" Its nearest competitors where you don't see Disney offering content that didn't get produced in Hollywood.There's very little in the way of non-Americanized and American-oriented content, whereas Netflix's content, you can bounce between stuff that is your very classic Hollywood trope to something that's completely out of the ordinary like tentpole level production on, say, Cowboy Bebop, or Marianne or Squid Game
"And while there definitely has been some dialing back with regard to how they've cut some various high-profile super expensive titles on their platform. I fully expect that money is going to be redirected for even more nichified entertainment and also, I think that they will continue to find that discovering new talent and bringing up new talent rather than trying to shoehorn a very high-profile A-list talent"
I think this sums up some of their advantages : Decentralized production/ international content/ global distribution = global virality ; no one is close to this so far.
I think a volume strategy is the only reliable way to build a long term business model. Unless you have world class IP like Disney and still its value can decrease over time and you need to come up with new IP which can be tricky to do if you don’t produce enough volume. Creative arts are an uncertain process( for example a couple of no names like the Duffer Brothers can come up with stranger Things ;Money Heist was a low cost Spanish production that had low viewership in the local channel)
What would I like to see? : Less Irishman and more Money Heist.
What is going to happen? Is Netflix going to become the aggregator or could it be bundled? - So far the former is more likely in the US (AVOD and fragmentation) but Netflix global dominance is unappareled. Can Netflix become the Youtube of TV or are they going to become another channel?
2.How do you ensure that people watch the appropriate content
So when you have a volume strategy you want to ensure that the viewers watch all the content you are producing ( you don’t want to be Prime Video with thousands of titles and awful curation). UX and curation has to keep improving and while it is the best out of the streaming companies it needs to keep getting better.
According to a 2020 interview in times magazine 10% of the workforce at the moment was working at discovery. I would like to them to Improve personalization even further , more emphasis on this (fast laughs does not even has an android version and they are just releasing the feature in Tvs).
However the lead is still huge as not a single show besides GOT has achieved the same global virality in the other platforms such as Netflix; this is harder than what it looks and that is why big tech is renting sport rights and pursuing more expensive productions. Take a look at the most watched Netflix series every week and you will see that around 50% are non-Americant.
3. How do you nurture and monetize the IP so you become a more profitable company?
This is an output. However it is not easy to master and has proved elusive for Netflix
What would I like to see:
°Cultivating franchises in order to be ahead of monetization , gaming is just another tool to monetize or nurture the franchise
°Theatrical first for the big budget movies then streaming ; why would you forego this revenue stream?
°Disney still has some advantage as they are able to better cultivate and monetize their franchises ( parks, resorts, comics, toys, and overall culture) but this should diminish over time ( it is more replicable ). The value of legacy IP while still huge (900M Dr Strange box office) should decrease over time and the key point is coming up with new IP ( can you effectively do that in a global world with a NA top down focus?). How can you effectively create quality if the outcomes of creative arts are uncertain?
Other outputs such as password sharing should not be the focus ( if you provide enough value you can improve monetization over time).
Summing up I think the global nature of the business(almost 50% of their Europe, South American and Africa shows appear in global rankings)/ decentralization/UX and focus are unapparelled. However I think AVOD effectively increases the dispersion of outcomes, the current macro environment is not favorable (inflation + real experiences vs ecommerce and streaming) and the next 100M subs could prove to be harder to achieve than I expected as it could take more time ( adoption depends on many factors they don’t control; however at these prices you don’t need high growth to make a good return).
The hardest think in this environment is to discern the impact from competition vs macro.
So far I believe it is more of the latter; we'll see.
Subscale players like Peacock need Roku in order to get traction and I think they will eventually be aggregated to the Roku channel. Despite that, it´s still early days, and Roku barely has an international presence. I´ll be paying attention to aggregators over the next few years
This is a phenomenal article. Appreciate your intellectual rigour. Great job.
Thanks for your kind words , I'm glad you like it
Fantastic write-up! Would love it if you could provide and update given recent slowdown in subscribers and massive share price decline.
Hey Jacques here are my thoughts:
None of what I say should be considered as investment advice ( do your own work)
Netflix has gotten crushed since I wrote the thesis. . Summing up I think the dispersion of outcomes has increased and while I believe this is still a good company and a good long term opportunity (short term is bumpy) my confidence has decreased ( I don't like how the industry is evolving towards AVOD + more fragmentation).
We'll see
I hold a position
--- What Happened?---
The combination of COVID hangover (people travelling more and online shopping/streaming less) + macro + more saturated market than I expected has proved to be a lethal blow.
Netflix in the US is especially vulnerable to subscriber loss, as the subscriber base is far more penetrated. This led to the largest decline in net US subscribers in the past ten years; the upcoming months do no bode better and Netflix has guided towards subscriber losses over the next quarter. The subscriber base was more penetrated than I thought and the marginal subscribers are very price sensitive
Netflix, among others, has suggested a variety of contributing reasons for rising churn, including the price hike and increasing competition.
According to Ampere low household incomes are the ones who have churned the most ( that is why management thinks that AVOD makes sense). The reality is that the absolute levels of churn are way lower than in previous price hikes; however given that the subscriber base is more penetrated and gross adds are much lower that leads to higher net losses
Based on alt data Q2 looks even worse ( same dynamic and even higher levels of churn). On top of this we are looping a complete reopening of the economy, an increase in travel and inflationary economy which makes comparisons even worse
However there is very little that leads me to believe that the competitive position has deteriorated:
1. Ampere data: amongst US Netflix leavers in Q1 2022, most users had not signed up to another SVOD service in the 2 months prior to churn. Users who did stack services generally churn from Netflix less often. Only a very small percentage of US Netflix leavers switch to another SVOD service soon after churn, suggesting that churn in Q1 has not been predominantly competition-driven (7% of churned subs).
2. CTV Nielsen viewership data: Netflix has held its market share since 2021. However the fragmentation is increasing and the landscape is less concentrated ( more streaming services emerging).
--- My take/ conclusions ---
°Monetizing password is just an output, I will focus on inputs
°AVOD: I see why management feels pressured to release AVOD ( and channel checks seem to point that it would be revenue accretive). However AVOD decreases barriers of entry and makes the industry prone to aggregation ( you would need no scale anymore and channels like Google TV , or Fire could potentially aggregate fragmented inventory) = Increased uncertainty about the future business model
° Accounting/CF: if you adjust for non released content ( still in production or not released) the cash flow is quite close to the amortization expenses as the amortization is not linear ( it is frontloaded). Another output not an issue for me.
° Competition: audiences are fragmenting and everyone and their mother is eating into Netflix video hours ( Tik Tok, FB , SNAP publisher content etc) while there are only 24 hours per day.
I think there are 3 key questions
1.How do you come up with great content that people want to watch?
At the end of the day this is the key. This is the capital allocation business so how do you allocate capital more effectively?
Constellation software has taught us that the best way to allocate capital is to build a decentralized structure ( Less than 50 people greenlight content in Disney vs +400 in Netflix) YouTube would therefore be the best structure and Netflix is the closest you can get to YouTube in scripted content ( as content costs money and is not user generated; see my essay).
According to the former product innovation chief at Netflix:
" Its nearest competitors where you don't see Disney offering content that didn't get produced in Hollywood.There's very little in the way of non-Americanized and American-oriented content, whereas Netflix's content, you can bounce between stuff that is your very classic Hollywood trope to something that's completely out of the ordinary like tentpole level production on, say, Cowboy Bebop, or Marianne or Squid Game
"And while there definitely has been some dialing back with regard to how they've cut some various high-profile super expensive titles on their platform. I fully expect that money is going to be redirected for even more nichified entertainment and also, I think that they will continue to find that discovering new talent and bringing up new talent rather than trying to shoehorn a very high-profile A-list talent"
I think this sums up some of their advantages : Decentralized production/ international content/ global distribution = global virality ; no one is close to this so far.
I think a volume strategy is the only reliable way to build a long term business model. Unless you have world class IP like Disney and still its value can decrease over time and you need to come up with new IP which can be tricky to do if you don’t produce enough volume. Creative arts are an uncertain process( for example a couple of no names like the Duffer Brothers can come up with stranger Things ;Money Heist was a low cost Spanish production that had low viewership in the local channel)
What would I like to see? : Less Irishman and more Money Heist.
What is going to happen? Is Netflix going to become the aggregator or could it be bundled? - So far the former is more likely in the US (AVOD and fragmentation) but Netflix global dominance is unappareled. Can Netflix become the Youtube of TV or are they going to become another channel?
2.How do you ensure that people watch the appropriate content
So when you have a volume strategy you want to ensure that the viewers watch all the content you are producing ( you don’t want to be Prime Video with thousands of titles and awful curation). UX and curation has to keep improving and while it is the best out of the streaming companies it needs to keep getting better.
According to a 2020 interview in times magazine 10% of the workforce at the moment was working at discovery. I would like to them to Improve personalization even further , more emphasis on this (fast laughs does not even has an android version and they are just releasing the feature in Tvs).
However the lead is still huge as not a single show besides GOT has achieved the same global virality in the other platforms such as Netflix; this is harder than what it looks and that is why big tech is renting sport rights and pursuing more expensive productions. Take a look at the most watched Netflix series every week and you will see that around 50% are non-Americant.
3. How do you nurture and monetize the IP so you become a more profitable company?
This is an output. However it is not easy to master and has proved elusive for Netflix
What would I like to see:
°Cultivating franchises in order to be ahead of monetization , gaming is just another tool to monetize or nurture the franchise
°Theatrical first for the big budget movies then streaming ; why would you forego this revenue stream?
°Disney still has some advantage as they are able to better cultivate and monetize their franchises ( parks, resorts, comics, toys, and overall culture) but this should diminish over time ( it is more replicable ). The value of legacy IP while still huge (900M Dr Strange box office) should decrease over time and the key point is coming up with new IP ( can you effectively do that in a global world with a NA top down focus?). How can you effectively create quality if the outcomes of creative arts are uncertain?
Other outputs such as password sharing should not be the focus ( if you provide enough value you can improve monetization over time).
Summing up I think the global nature of the business(almost 50% of their Europe, South American and Africa shows appear in global rankings)/ decentralization/UX and focus are unapparelled. However I think AVOD effectively increases the dispersion of outcomes, the current macro environment is not favorable (inflation + real experiences vs ecommerce and streaming) and the next 100M subs could prove to be harder to achieve than I expected as it could take more time ( adoption depends on many factors they don’t control; however at these prices you don’t need high growth to make a good return).
The hardest think in this environment is to discern the impact from competition vs macro.
So far I believe it is more of the latter; we'll see.
Best
Nice write-up.
Re: Roku’s power did you see what happened with them and Peacock? Would scare me if I was a ROKU shareholder.
Hey Jaime! thanks for the comment
Subscale players like Peacock need Roku in order to get traction and I think they will eventually be aggregated to the Roku channel. Despite that, it´s still early days, and Roku barely has an international presence. I´ll be paying attention to aggregators over the next few years