This sub-bullet in CNBC’s “prepare you for the earnings report” article caught my attention:
On the surface, it’s clearly true. One bad earnings report won’t power Disney+ or HBO Max to 150 million subscribers. But as I reflected on it, the key variable is “when is soon?” By the end of the year, sure, Netflix is safe. But what about the end of 2020? Or 2021? If someone does catch up to Netflix, then the streaming wars will have a new champion.
Let’s see if the earnings report sheds any light on that question.
Strategy
Most earnings reports don’t reveal monumental shifts in strategy. This report would mostly qualify, except that Netflix did rule out a key potential revenue stream in fairly definitive terms.
“Neverflix”
At the end of last year, when it came to a Netflix show airing on a linear channel, I called Netflix the “company of Never”:
This earnings report doubled down on the fact that Netflix will NOT roll out advertising any time soon. I believe them and agree with this position. Adding advertisements will concretely change the user experience, likely leading to higher subscriber churn than the ad wizards begging for it expect.
I have softened on the position of “never” recently. I do appreciate Netflix’s relentless focus. A good strategy is a focused strategy, and saying “No” to efforts that divide your energy can be a wise tactic. But let’s not go overboard. For example, releasing episodes weekly.
I’d argue that decision is not material to the Netflix customer experience. Instead, binge releasing is a decision they made, and now cling to unnecessarily. Why isn’t, for example, Stranger Things 3 being released weekly? Having one series go weekly won’t lead to customer churn. There may be a 10,000 angry fans on the internet who want the binge, but again that’s noise, not signal. (I like this issue so much, I wrote an article for another publication coming out soon.)
Oh, and one other “never” that should really worry Reed Hastings.
The Never That Terrifies Me: Aggregation
If I understand the Netflix bulls correctly, the sky-high stock price—if it isn’t based on past performance being sky-high—is due to the fact that at some point, Netflix will be TV. Netflix isn’t just “another streamer”, it’s the future of TV. But is that future already in the rear view mirror?
Currently, many people get their HBO, Showtime and Starz through Amazon Channels. More will get Disney+, HBO and Showtime through Hulu. Apple will have another set of channels. Already, people experience streaming through Roku, and they added the ability to buy channels too.
In other words, as Ben Thompson coined, the streamers are getting aggregated.
Eventually, the aggregators will offer bundles or discounts. Netflix, though, won’t be included because they have started pushing everyone to subscribe through the internet, instead of through those platforms. They did this because all those aggregators charge fees to sell the channels. I see two sub-optimal outcomes for Netflix as a result:
1. Eventually they get aggregated, which means they are “just” HBO.
2. They struggle to get awareness and presence outside the bundled aggregators.
Either choice is bad, and the sooner Netflix realizes it the better. (Hopefully more to come on this topic.)
Distribution: The good news
If avoiding digital bundlers is the downside case for Netflix, the upside case is integration with MVPD providers. Netflix announced that they will now be on AT&T’s devices that enable streaming integration. I’ve seen this work on Cox’s (via Comcast) Contour system, and it really does complement the cable bundle. Amazon Prime/Video is right behind them, and both are well ahead of the new streamers to catch up to their head start.
Competition: This is the low water mark for digital streaming.
Speaking of new SVODs, the other looming cloud over Netflix is the impending launch of the DAWNs: Disney, Apple, Warner-Media, and NBC-Universal. (Hat tip to Variety for coining.) Obviously, this will put pressure on Netflix to keep prices low to stay competitive—they are just below HBO in cost—and keep spending high to produce original content—they lap everyone when it comes to spending.
More interesting is how this will impact subscribers. While the launch of these streamers may inspire more cord cutting, which would benefit Netflix, the launch could also lead people to “cutflix” and trim the number of streaming options. But let’s move to our next section to discuss those implications.
Subscribers
How Many Subscribers Will Disney+ Grab?
When in doubt, go to the segmentation. Segments are groups of likeminded customers who use a product. Millenials are a good example of a segment. They use Netflix because they cut the cord. Teenage-skewing rom-coms could appeal to them. Another segment is high income earners who added Netflix to their cable package. They use Netflix to bolster their content options and stay in the conversation. Buzzy, award winning shows appeal to them.
With Disney+, the core segment will be “families with kids”. I’d further break this segment into two: “families with kids who also watch adult shows” and “families who only use Netflix for kids content”. I imagine some of you can’t imagine the latter group exists, but I’m here to tell you it does. The question is, how large is that group?
Let’s do some back of the envelope calculations. Again, this isn’t a scientific inquiry, but jotting some numbers down to put the strategic situation in context. First, here’s my quick pull of US households with kids in America. (Yep, I’m limiting this to America for now; I don’t know the rest of the world enough to opine.)
So then I’m going to make a few assumptions, and see where that gets us:
I’ve read the argument that Disney+ may launch and actually help Netflix. I’ve read the reverse argument too that Disney+ will cannibalize subscribers. We’re probably being too confident in our predictions if we pretend right now we know what will happen. Instead, my back-of-the-envelope predictions suggest that losing customers to a Disney launch is well within the realm of probability.
That’s just one segment. We could repeat the exercise with multiple other groups to get a better idea. Then repeat with HBO Max, CBS All-Access, NBC-Universal TBD and Apple TV. (Though Disney has the clearest target demographic.) We’re about to be in a very competitive digital space.
Can Competitors Get to 60 Millions Subscribers?
The above section really hits how much Netflix has built the narrative around its own terms. That term is subscribers.
To tie back to the initial quote, Netflix is way out in front. The question is how long that lasts, and what happens when it isn’t true anymore. See, the question I’m really curious about is if Wall Street cares if you have one service offering 60 million subscribers to the same platform, or 90 million subscribers across three different services? If they’re all paying, does it matter? HBO, for example, has long bundled Cinemax subscribers with their HBO count, even though a huge number of customers subscribe to both. But investors and jounralists still just say, “45 million US subscribers”.
This got me thinking: how quickly could Disney catch up? Or AT&T? Or CBS? So I sketched some back of the envelope scenarios:
To be clear, these are just in the US. I’m not even counting international growth. And I got Disney to 150 million subscribers.
And are any of those future guesses ridiculous? ESPN is THE brand name in sports, and Disney is the brand in family entertainment. Hulu already has 28 million subscribers. Also, Disney owns 50% of A&E, so buying out the rest and using History/A&E as the basis for a lifestyle programming isn’t a stretch. Same for CBS merging with Viacom and AT&T using TNT’s sports/CNN programming for something. (Though to stymie this thought experiment, AT&T said they will put sports on HBO Max. I do not get their strategy.)
The T-Mobile Question
Among the causes of the US subscriber decline, the price hike was the biggest culprit. I wonder if you could connect a lot of that churn to T-Mobile.
When Netflix raised prices, T-Mobile passed that $2 increase along to customers, meaning some had to either drop to a lower tier or they had to start paying more. (One of the big impacts of a price increase is it usually causes customers to reevaluate their bills.) Likely some of the churn comes from T-Mobile subscribers realizing they pay for Netflix separately, so not paying the extra $2 while T-Mobile essentially paid for an inactive subscriber. (Monthly active user percentages would help us figure out how big this group is.)
It proposes up the interesting question: how many US subscribers are from this T-Mobile deal? Given how much T-Mobile advertises it, it can’t be insignificant. And they have 81 million subscribers. If the Sprint merger goes through, one of the Hulu or Netflix deals has to go away. Are those deals material to their respective businesses? I don’t know and couldn’t find any estimates online.
Meanwhile, this is another potential speed bump on Netflix customer acquisition. Going forward, if I understand the reports right, T-Mobile is only offering Netflix’s standard definition, 1-stream at a time plan going forward. Who watches TV in standard definition still? This is just another example of how customer acquisition costs will raise for everyone in the near future.
My Prediction on Netflix domestic subscribers
To keep myself honest, I like to make genuine predictions with numbers. Why? Because it is damn hard to do well. (The old saw is economists are great at making predictions, but not very good at being correct. Should we replace economists with “media futurists”?)
In January, I tried to predict Netflix’s 2019 final subscriber total, and frankly Netflix regressing by a hundred thousand subs was great for my prediction of 60 million year end. Take a read for my thought process.
Financials
As always the number that I think drives their strategy is the free cash flow losses. If Netflix didn’t have to raise prices this year, they likely would have exceeded $4 billion in losses.
They’re rightfully terrified of how the market would react if say cash flow losses went to $5 billion this year. (And they easily could have with some more spending and no price increases.) I’ll add, while it is much tougher to play with cash flow then profits, there are still some ways to manipulate timings to say keep the “calendar year” number under a certain point. That, though, only delays the inevitable. This is one of those long term views where if this year ends up between $3.5-$4 billion in FCF losses, look to see if Q1 of 2020 sees a sudden spike.
Still, I remain skeptical this number can go down if one other number doesn’t also start coming down. The number to monitor here is the “Streaming Content Obligations”, which are off balance sheet agreements like the Disney output or Shonda Rhimes deal that they will still have to pay. Here’s that line in their letter to shareholders:
It’s flat—which is good—but the question is can it last? If they need to replace big series and the departing movies with more spend, then I’m skeptical.
