Netflix in Content Crosshairs

Lost in Netflix’s strong third-quarter subscriber growth numbers was the streaming media giant’s surprise revelation about the ownership status of its original content.

With Netflix spending upwards of $12 billion on original content in 2018 – underscored by $18 billion in third-party content obligations – the service said its alarming negative free cash flow is about to level off.

To assuage naysayers, Netflix (on page three of the shareholder newsletter), disclosed the ownership status of original programing – a dynamic that will continue to change as the Walt Disney Co. pulls original movies and related content from Netflix for its own pending over-the-top video platform.

Netflix says it has three major categories of content: licensed non-first-window content, such as “​Shameless​”; licensed original first-window content, such as ​“Orange Is the New Black”(​owned and developed by Lionsgate), “Ozark” (Sony Pictures Television) and “Insatiable” (CBS); and owned original first-window content from its own studio, such as ​“Stranger Things​.”

The latter category also includes “Big Mouth,” “The Ranch​,” “​Bright​,” “Godless,”​“The Kissing Booth​,” ​“3%,”​“​Dark,”​“​Sacred Games”​and “Nailed It​.”

Within those categories there are lots of subdivisions and per-territory treatments, but those are Netflix big three content buckets.

Netflix claims the classification of content will help reduce its reliance on outside studios, provide greater control over content it creates in-house (i.e., long-term global rights), increase brand/consumer product tie-ins, and lower costs (avoiding third-party studio mark-ups).

“To do this, we’ve had to develop new capabilities to manage the entire production process from creative support, production planning, crew and vendor management to visual effects, to name a few,” Netflix management wrote in the letter.

At the same time, Netflix is staking its future largely on proprietary content, whose popularity is at the whim of an increasingly fickle consumer.

Indeed, with the exception of Emmy-nominated “Stranger Things” and “Godless,” most of Netflix’s award-nominated original content is third-party sourced. The rest is a “hot mess,” according to Wedbush Securities media analyst Michael Pachter.

“We think it is downright quixotic of the company to presume that it can produce compelling content that will replace the licensed content it currently displays from major studios,” Pachter wrote in a note.

Pachter believes that should Netflix somehow default on its mushrooming debt, creditors would be hard pressed to convert any of the content into cash, particularly any of the capitalized content that is owned by others.

“It is simply impossible to comprehend how Netflix has been able to capitalize over $18 billion of its content spending with so few compelling owned original television series and films,” he wrote.

Analyst: Netflix Can Stop Negative Cash Flow with Price Hike

With more than 130 million subscribers and growing globally, SVOD behemoth Netflix has few problems – except an operating strategy bent on spending every free dollar (and more) it generates.

The service reported negative free cash flow (FCF) of $559 million in the most-recent quarter ended June 30 – part of a projected $3+ billion negative free cash flow in 2018.

Free cash flow is the cash a company produces through its operations, less the cost of expenditures on assets. In other words, FCF is the cash left over after a company pays for its operating expenses and capital expenditures.

And with Netflix on a breakneck pace to outspend ($13 billion this year) every competitor on original content, the SVOD pioneer continues to significantly exceed internal fiscal resources – typically a red flag to Wall Street.

But Netflix isn’t a typical company.

In Q2, the service completed a bond (debt) deal, raising $1.9 billion. At the end of the fiscal period, its gross debt stood at $8.4 billion, with a cash balance of $3.9 billion and a $500 million undrawn credit facility.

“We judge that our after-tax cost of debt continues to be lower than our cost of equity, so we anticipate that we’ll continue to finance our capital needs in the high yield market,” CEO Reed Hastings and CFO David Wells wrote in the shareholder letter.

Michael Pachter, media analyst at Wedbush Securities in Los Angeles, contends Netflix could remedy (break-even) its cash flow issue by raising the subscription price to $15 monthly.

“While an increase of $4 per month for domestic subs and $6 for international subs would add around $7.6 billion to revenue, more than offsetting negative free cash flow, we think that higher pricing would result in even higher content and marketing spending,” Pachter wrote in a note.

In other words, Pachter believes Netflix would continue spending like a drunken sailor.

While any mention of a price hike undoubtedly causes nightmares for Netflix brass following the well-documented fiscal debacle in 2011 when it raised – by 60% — the price of a popular hybrid streaming/DVD subscription plan. More than 800,000 subs dropped the service, and Netflix shares plummeted 75% in value, losing billions in market capitalization.

Pachter said anything charged above $15 per month would likely drive substantial profits, although, at higher prices, subscribers would expect more, and content license costs would likely rise.

“We estimate that at $20 per month, Netflix would generate around $3 per month in cash profit per subscriber,” he wrote.

In the meantime, Pachter expects Netflix to impose modest price increase every 18 – 24 months for the foreseeable future and thinks it could take as long as eight years to generate meaningful positive free cash flow.

To do so, Netflix has to keep adding subs at current growth levels – not unreasonable considering original programming continues to generate the bulk of online attention among consumers, according to Parrot Analytics.

“[Netflix] is likely to top out at around 200 million global customers,” wrote Pachter. “At that level, FCF would be $600 million per month, or $7.2 billion annually.”

Netflix reports Q3 financial results Oct. 16.

 

 

 

 

 

Analyst: Roku Channel Company’s Fastest Growing Revenue Driver

Roku cut its teeth more than 10 years ago helping Netflix – through a standalone streaming device – create the subscription streaming video market that now dominates home entertainment.

As a publicly-traded company, Roku must grow revenue to appease Wall Street and investors. Doing so exclusively selling low-cost consumer electronics and streaming sticks in an increasingly saturated market won’t work long-term.

About a year ago, the Los Gatos, Calif.-based tech company announced the launch of “The Roku Channel,” a new streaming channel on the Roku platform specifically dedicated to giving users free access to ad-supported catalog movies and TV shows.

With more than 22 million registered users – some of whom pay for access to third-party OTT video services via Roku – the company contends the channel affords advertisers a built-in audience with measurable data and favorable demographics.

And Michael Pachter, media analyst with Wedbush Securities in Los Angeles, agrees.

“We estimate that [average revenue-per-user] from The Roku Channel is the fastest growing contributor to overall revenue growth at Roku,” Pachter wrote in an Oct. 5 note.

The analyst expects the channel to be Roku’s highest revenue contributor by the end of 2019, and for it to continue to grow revenue as Roku migrates internationally.

Specifically, Roku will be able to increase revenue by charging advertisers more (CPMs) to target consumers – and installing the Roku app in third-party Internet-connected televisions, according to Pachter.

“Given all of the data Roku has on its audience and its ability to place finely targeted advertisements for its ad-partners, [the company] will be able to accelerate revenue growth,” he wrote.

Indeed, Pachter estimates The Roku Channel generated 1% of Roku’s total streaming hours in Q4 2017 after it launched. He expects that streaming time to increase to 20% by Q4 2020.

In the most-recent Q2 results, Roku said its branded channel was among the Top 5 used, generating $90.3 million in revenue. Total streaming hours (including third-party apps) increased 57% to 5.5 billion hours.

Pachter contends there are an average 1.5 ad impressions per hour with Roku stating CPMs in the $30 range.

“We expect average-revenue-per-user of [The Roku Channel] to reach $3.68 in 2018, $7.45 in 2019, and $11.28 in 2020,” he wrote.

Roku has recently expanded the reach of its branded channel to some newer Samsung TV models, as well as a standalone website. Roku has just begun to expand the channel internationally, beginning in Canada.

To help boost advertising partnerships, Roku in June launched “Roku Audience Marketplace,” which assists advertisers in targeting specific audience segments, utilizing Roku’s detailed household data.

“With more targeting capabilities, we expect Roku’s CPMs to rise,” wrote Pachter.

 

Netflix’s Other Achilles Heel: SAC

NEWS ANALYSIS – Netflix projects it will add 1.2 million domestic subscribers in the second quarter (ended June 30), which would give the SVOD pioneer nearly 58 million subs in the United States.

A conservative expectation – given Netflix’s market saturation – that will either be confirmed or denied July 16 when the service reports Q2 financial results. Netflix added 1.96 million subs in Q1 compared on a forecast of 1.45 million. Still, concern lingers among investors.

“Should domestic additions fall below last year’s 1.07 million level, we expect Netflix shares to decline,” Michael Pachter, media analyst at Wedbush Securities in Los Angles, wrote in a note. “Should guidance for Q3 net subscriber additions fall below last year’s Q3 additions (0.85 million domestic, and 4.45 million international), Netflix shares may react even more negatively.”

While missing its subscriber growth estimate would undoubtedly send Netflix bears and short sellers into a frenzy, a bigger concern is how much the service is spending acquiring new subs in the United States.

Netflix spent $228 million on domestic streaming in Q1, which was nearly double the $115 million spent in the previous-year period. That equals about $116 in subscriber acquisition cost (SAC) spent attracting each new domestic sub. Netflix spent about $81 for each new sub last year.

With the standard Netflix subscription plan costing $10.99 monthly, it will take the service more than 11 months to recoup the SAC spent acquiring each domestic sub in Q1. In other words, it is costing Netflix more to attract a dwindling new sub base.

By comparison, the service spent about $46 in marketing for each new subscriber outside the United States – up slightly from $44 spent during the previous-year period.

As many observers focus on sub growth, SAC and Netflix’s burgeoning content spend ($8 billion in 2018), the service’s free-cash-flow loss continues to grow exponentially as well. The company has projected a free-cash-flow deficit this year upwards of $4 billion – that’s on top of content spending!

“With declining domestic growth rates and spiraling acquisition costs, Netflix faces a very real set of challenges if it is to continue to command such a strong position,” Richard Broughton, research director at London-based Ampere Analysis, wrote in a note. “Our research shows that while Netflix can continue to enjoy relatively low acquisition costs for international subscribers and a buoyant market keen to embrace SVOD, it cannot afford to take its eye off the ball in the domestic market, even momentarily. Its ability to grow ARPU [average revenue per user] will be critically important to manage long term growth – domestically and abroad.”

 

Analyst Calls Appeals Court’s Gambling Decision ‘Dangerous Precedent’ for Online Video Games

Last week, the Ninth Circuit Court of Appeals in San Francisco overturned a lower court ruling that found free-to-play online video games don’t constitute gambling under Washington state law.

Specifically, the appeals court ruled in favor of the plaintiff, who had spent $1,000 on “coins” on a virtual casino slot game to extend play. Players are provided a number of free coins daily but can purchase additional coins to extend play within a 24-hour period.

That payment option, according to the appeals court, held “intrinsic value,” and constituted gambling under state law.

To Michael Pachter, media analyst at Wedbush Securities in Los Angeles, the decision has ramifications for free-to-play online video games that allow players additional turns for a fee.

Activision’s King Casino generated nearly $2 billion in revenue in 2017, including a $1 billion in the U.S. Most of the revenue coming from the purchase of “boosters” in games, which accelerate the solving of the particular game or extending play.

Zynga generated $850 million in revenue, with an estimated $400 million coming from the purchase of time-saving options.

“Should the Circuit Court’s decision be applied in other states, these companies may face a series of lawsuits,” Pachter wrote in an April 2 note.

The analyst expects the latest decision to be appealed by a “more rationale” court that does not render value on virtual video game pieces.

“However, until that happens, there is some risk that Activision and Zynga will see increased legal risk to their ongoing operations in Washington state,” Pachter wrote. “Should other states decide to cite the [lower court] decision as precedent, we may see an uptick in legal activity elsewhere.”

MoviePass Looking to Avoid ‘Facebook’ Fallout

NEWS ANALYSIS — Movie theater subscription service MoviePass’ recent announcement offering first-time annual subscribers access for $6.95 a month – 30% below the standard $9.95 rate – underscores increasing consumer concern about data privacy.

CEO Mitch Lowe said the price cut is an attempt to make the moviegoing experience “easy and affordable” for everyone. Apparently, paying less than $10 monthly to watch one theatrical screening per day amounts to fiscal overreach for consumers.

Or could it be in reaction to Lowe’s loose lips at a recent industry event (first reported by Media Play News), dubbed, “Data is the New Oil: How Will MoviePass Monetize It?” in which he bragged about MoviePass tracking subscriber activities before and after screenings?

“We watch where you go afterwards,” he said without concern.

Of course, Lowe had no idea about the looming Facebook data tsunami and ensuing fallout after the social media behemoth admitted selling the personal data of 50 million subscribers to a foreign consulting firm with ties to the 2016 presidential election.

The debacle has reportedly cost Facebook more than $60 billion in market capitalization, scrutiny by the Federal Trade Commission, calls for increased regulation and founder/CEO Mark Zuckerberg’s pending grilling before Congress.

Not to mention increasing public distrust how Internet giants Amazon, Google, Yahoo and others track user behavior and what they do with that information.

To be sure, Lowe rushed out an email to subscribers claiming his comments about MoviePass data mining had been mischaracterized.

Wedbush Securities analyst Michael Pachter isn’t so sure.

“The media reaction since indicates that many do not believe it was a ‘mischaracterization,’ especially given Facebook’s recent debacle with Cambridge Analytica,” Pachter wrote in a March 26 note.

Indeed, MoviePass hasn’t explained what it does, or will do, with the subscriber data – other than market/leverage it to exhibitors for reduced ticket prices or a percentage of concession sales — a reality, Pachter contends, harbors ongoing concern about the service’s long-term viability.

“Additionally, we now harbor concerns about the potential for consumer backlash should [MoviePass] collect certain data without consent, or improperly use the data it collects,” he wrote.