As of Wednesday, I was flailing for a story of the week. Well, thank you Thursday! And happy Halloween to everyone. Stay safe.
Lots of stories, but we have to go with Netflix…
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Most Important Story of the Week – Netflix Raises Prices. But Why?
Not a lot is truly surprising in the streaming wars. Take the recent service launches. First, a pivot to streaming is rumored. Then confirmed. Then details are leaked. Then when they roll out, for the most part they are what we expect.
Or take Netflix. They usually telegraph price hikes a few months early to help prepare us. In their last earnings call, for example, they hinted that with all the content coming in the second half of 2021, maybe a price hike was due. So we set our watches for the once every two year price hike.
And then they announced on Thursday it’s coming in November!
Well, increasingly Netflix is shifting from a company focused on growth to one focused on making money. This is a typical transition as a company ages. Netflix is “entering middle age” as I recently wrote. The challenge for Netflix is to manage this transition while sustaining their stock price.
Which is hypothetically the point for every company, but seems even more important for Netflix. My feeling is that the debate between the bulls and the bears is really about what financial metrics we’re looking at. Some analysts only focus on the subscriber growth, either US or global. Some toss in revenue, which has grown with subscribers. Then a select few focus on the free cash flow and subscribers.
The tough part for any company is getting all of the metrics to go up simultaneously. I’m reminded of a story the Manager-Tools founder Mark Horstmann would tell. Some executives are sitting around looking at a set of inputs for an engineering project. If you add weight, you decrease speed, but maybe save costs. If you cut costs, the quality goes down. And one exec says, “Well it would be great if all the numbers would go up simultaneously!” Yeah it would! That’s the tough part of engineering. And strategy.
Indeed, that’s the goal of a good strategy: to increase all your performance metrics simultaneously. But that’s really rare!
We see this with Netflix. Essentially, they’re shifting from one strategy to their next stage of life, but that comes with lots of tradeoffs. To see this, let’s start with the inputs Netflix can control. Roughly, I’d say there are three big buckets:
– Prices for customers
– Short-term content spend (licensed content)
– Long-term content spend (library)
These lead to a few key metrics that relate to the strategies:
– Revenue (the top line amount of money someone makes)
– Free cash flow (the amount of money a firm actually makes, as distinct from profit.)
(Why not use profit? Because content amortization plays so much of a role that it’s hard to evaluate. Some folks use EBITDA as a proxy for profit, which cuts out some of this.)
Those financial outputs also tie to the lifestage/strategy of a company, neatly summarized by Salil Dalvi in this tweet, which inspired this article:
Seems like your thesis is that Netflix is having a hard time triangulating between 3 competing goals:
1-near term viewership
2-long term IP/franchise development
Welcome to the NFL.
— Salil Dalvi (@sd_so) October 21, 2020
Thus we can summarize it like this, with each stage/strategy having different inputs that drive the strategy and different financial metrics:
– “Growth” phase:
Key financial metric: Subscribers.
Key Inputs: Low prices, lots of short-term content spend.
– “Building” phase:
Key financial metric: Revenue and Capital expenditures
Key Inputs: Wholly-owned content spend.
– “Make money” phase:
Key financial metric: Free cash flow
Key Inputs: High prices, lower content spend.
Netflix started life in the “growth” phase. That’s what allowed the stock price to explode. And they rode that, while pivoting to the “building” phase, that meant spending more than the rest of Hollywood combined on content. The goal was to build a library/moat to sustain their subscriber advantage. (The challenge is how much of that content they own, even now.) If they are now pivoting to a “make money” phase, how does that impacts their stock price?
I’ve been deliberately using “tradeoffs” as the word to describe this because for the most part it is a different combination of inputs for different strategies. Netflix would love to grow subscribers and revenue and free cash flow, but it can’t/never has. It could do two of those simultaneously (revenue and subscribers, for example or revenue and cash flow), but not all three. The huge growth of the last decade came with a big price tag, losing $10 billion in cash in the last 12 years, and more in opportunity costs.
Ironically, the “Covid Caveat” times may have forced Netflix to move to “make money” sooner than their plans. The Q2 immense lock down growth pulled forward future growth, which hurts the growth narrative for Wall Street. Meanwhile, shutting all productions basically will allow them to be cash flow breakeven to positive for the year without seeming impacts on subscriber churn.
Once you realize Netflix is no longer focusing on growth, a lot of recent decisions make a lot of sense:
– Raising prices in the United States? All about boosting revenue and cash flow.
– Ending free trials? Reduces churn and boosts revenue per new subscribers.
– Cancelling underperforming shows? Reduces overall content spend.
– Rearranging the entire TV team? Actually, no this isn’t explained by the goal to drive revenue. (Listen, some grand theories can’t explain everything.)
In other words, in some territories growth is running out. And meanwhile Netflix is constantly worrying about what Wall Street thinks. If they show positive cash flow one year, but then lose $3 billion the next, does that crush the price? Or if they show stalled global subscribers without higher revenue, does that lower their multiple? Or just low single digits revenue growth? What does that do to the valuation?
When you’re one of the highest price stocks in all history in terms of profit or cash flow, you worry about what will make the market finally change their mind.
Some final implications:
– First, you really see that the traditional conglomerates have a different tradeoff. They’ll hemorrhage current cash flow by going to streaming, but they won’t have to worry about building long term libraries. They already have those. After they catch up in the growth phase, this could be an advantage.
– Second, this shift isn’t necessarily global. Some territories will mature at different rates. Most of this story is a United States story. But, despite the narrative, by most metrics the United States is about 50% of Netflix’s business. (Like in revenue.)
– Third, this is what puts the Netflix stock in a different category than it’s fellow “FAANGs”. The others see booming user, revenue and cash flow growth simultaneously. Netflix has to choose.
– Fourth, this chart from Evolution Media Capital tells the story of the price hikes perfectly:
Other Contenders for Most Important Story – AMC+
AMC+ was announced in June as a bundle of AMC streaming services for one price of $5 on Comcast. The news earlier this month was that it expanded to the Amazon and Apple Channels programs for $9. (The streamers include AMC content, Shudder, Sundance TV, iFC Films and BBC America.)
I’ve been meaning to dig into this news for a pinch, since it’s a big strategy shift for a smaller strategy player. But it really deserves its own 2,000+ word deep dive.
In the meantime, I like this move for AMC, with the caveat that they’ll never win the streaming wars with it. Essentially, this is admitting that AMC knows their strategic limitations. (Analogies: this is the Frey’s allying with the Lannisters. Or Canada in World War II joining the winning team.) They don’t have the cash flow to build a technology platform. So let Apple, Comcast and Disney do that, and accept lower profit/cash flow with it. Meanwhile, the new AMC+ isn’t quite a bundle, but it is broader than the niche services. That’s smart.
Data of the Week/Entertainment Strategy Guy Update – The Straight to Streaming Market
Each week for the rest of the year, maybe for the rest of time, will be a referendum on whether or not films should go “straight-to-streaming”. This week had some fun updates on that. The big caveat is that one film doesn’t prove the thesis either way. Sort of like how no individual poll in the current election is decisive. Take the average.
Let’s start with the success. Borat 2, or whatever it’s long title is. Borat did what any film hopes for, which is to get tons of earned media exposure by becoming a national news story. (Thanks Rudy!) As such, it did really well for Amazon Prime/Video/Studios/Channels/IMDb. Here’s the quote Apptopia sent me:
Today’s finding: Amazon Prime Video just achieved its highest number of single-day installs (on mobile) on record (our data goes back to 2015) with about 520K on Sunday.
This is backed up by the Google Trends:
(The caveat is we can’t untangle how much folks were searching for news on Borat versus viewership. That said, I expect it will make it into Nielsen’s top ten in three weeks.)
Of course, a deal isn’t good just on performance alone. What matters is the price for that performance. Or return on investment. (Lebron James isn’t the best because he’s the best, but because he’s the best and his salary is capped at $30 or so million per year, when he could be worth double that.) The news via Deadline is this film cost $80 million to acquire directly from Sacha Baron Cohen.
So did Amazon Prime/Video/Studios/Channels make any money on it? I honestly don’t know. Folks have asked if I could run my “Great Irishman” model on it, but we cannot. Because we don’t have the Prime Video inputs. We know how many Prime subscribers there are as of January, but not how many folks actually watch the service, let alone value it. At $80 million, we’re definitely on the “needed to be a big hit” side of the ledger, but this looks like it got there. (We’re closer to running this analysis with Disney+ than Amazon because at least Disney gives us subscribers every quarter.)
(I’d add, we also don’t know the full terms for Borat 2. How long does Amazon have exclusivity? Do they have ownership later? We don’t know.)
Speaking of pay days, the best rumor of the week comes from The Hollywood Reporter (and others) that MGM was asking for up to $600 million for the rights to James Bond for some period of time. Which is eye-popping on one regard, but also eminently reasonable in the other. James Bond films make bucks at the box office, which means they make money in home entertainment and in subsequent windows:
The best summary of the landscape comes from Brandon Katz at Observer:
The Lovebirds (Netflix): $20M
Palm Sprins (Hulu): $22M
Greyhound (Apple TV+): $70M
Hamilton (Disney+): $75M#Borat2 (Amazon): $80M
Coming 2 America (Amazon): $125M
2020 has been wild
— Brandon Katz (@Great_Katzby) October 29, 2020
What I’d say is there is a ceiling to straight-to-streaming releases, and it’s right around $100 million production budgets. (If not a bit lower.) Every so often a streamer will go over–Netflix with The Irishman and Triple Frontier/6 Underground; Prime Video with Coming 2 America 2; Apple TV with the next Scorsese budget pit–but those are the two biggest, and even then they’ll likely lose money.
(This is why I wrote in the Ankler that the straight-to-streaming move could end “blockbusters” as we know it. And talent would lose a lot of money too.)
Most importantly, using my “need to make money” framework, MGM is the type of firm that needs to make money. If MGM spends $200 million to make a film, they can’t just lose money on it and make up some imaginary source of data/subscriber retention to justify it. They have Private Equity guys breathing down their necks to make a return.
So yeah, they explored selling to streamers, but at that price tag only theaters can make money on it.
Other Contenders for Most Important Story – Comcast Earnings Report
Comcast made the most “news” with their earnings report. So let’s rank the insights in order of importance.
- Content doesn’t have one home, it goes to the best platform.
With this quote alone, Comcast/NBC/Universal/Peacock has moved up my power rankings. I’ve been advocating this position for awhile, and loved it when CBS started airing The Good Fight on CBS. Essentially, you can easily overvalue “exclusivity” for streaming, and the goal is to make a good piece of content and make as much money on it as possible. This doesn’t apply to Netflix or Prime Video, since they don’t have other channels, but for NBC, Disney and HBO this absolutely should be the plan: make content, find the best first home, and then the second best home and so on. (Essentially HBO Max is already doing this with HBO shows.)
- Peacock has 22 million users.
Caveats abound. (How many active users? How many paid?) But at least they provided a number.
- Touting the executive reorganization.
If I were in Afghanistan, I’d hate it if my boss changed every six months in relentless reorgs. Instead, we simply changed the entire leadership every year. (Wait, that was fairly bad too. Truly an awful organizational decision.) Let’s hope this sticks and they finally have a streamlined organization with clear spans of control.
- Comcast is holding to their theatrical/PVOD plan, regardless of theater closures.
Which makes sense. They can’t delay forever, and at some point these costs are sunk.
- Cord-cutting continued, but decelerated.
Which is interesting. Here’s the best chart from Evolution Media Capital:
Comcast lost 253k residential video customers in Q3, but it was a pretty big sequential improvement from Q2. Q4 is usually one of the stickier quarters for churn, so there might even be further improvement through the rest of the year. $CMCSA pic.twitter.com/YyNbkWCh3L
— Tavish ZM (@TZM_TMT) October 29, 2020
Lots of News with No News – Rest of the Earnings Reports
Congratulations to Amazon, Apple and Google for providing very little insight into their streaming video businesses. Their earnings reports are a credit to a lack of transparency. We should break them up if for no other reason than because they make billions in cash but can’t bother to provide details into any of their business units.