Netflix under scrutiny

For all its manifest successes there are still question marks and an unusual level of unease about the Netflix phenomenon, writes Raymond Snoddy.

A remarkable thing happened in the early hours of 1 January this year. The number of Netflix subscribers passed through the 75 million barrier. Strictly speaking the landmark number just failed to arrive in time for the company’s fourth quarter results, but there is no mistaking the symbolic nature of the achievement.

The online video streaming company says it is now available in 130 countries, and as founder and chief executive Reed Hastings modestly puts it: “the whole world by the end of 2016.”

To get the whole world Netflix will have to talk its way into China this year and it could be a long conversation.

Even without China the US company hopes to add a further five million subscribers this year and take its number of hours of original programming to 600 – up from 450 last year.

The plans include new seasons for 30 original series, eight original feature films and a dozen documentaries as well as series for children.

Two original documentaries What Happened, Miss Simone? and Winter of Fire have both been nominated for Academy Awards.

In the past 12 months alone the Netflix share price has more than doubled to around $98 giving the company that elusive quality of momentum with shareholders.

Can anything stop Netflix now or dent its dominance in the domain it helped to develop – video entertainment streaming?

Has it passed through the pain barrier and on to the other side in the way that Google, Facebook and Twitter have managed to do and can now shrug off competitors?
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All three floated successfully, if at eye-watering prices, giving them the war chests to buy emerging rivals at an early stage as required.

The three seem permanent occupants of their chosen territory, although Twitter has more work to do in coming up with a money-making rationale.

Has Netflix managed to climb Mount Olympus and join that rare breed of best in class?

It may indeed be about to cross that notional threshold this year, particularly if it were to crack the Chinese market.

And yet for all its manifest successes there are still question marks and an unusual level of unease about the Netflix phenomenon.

The most obvious sign of the unease has been the volatility of the share price.

In the third quarter when Netflix failed to meet most of the expectations of the market, including the all-important rate of subscriber growth, the shares fell by 10 per cent.

Then they shot up again when the fourth quarter was better than expected.

Hastings tends to laugh off such volatility by saying he’s seen it all before and that’s just part of the Netflix story.

Debt is another part of the Netflix story. At the end of the year there was nearly $1 billion in long-term debt and the company has just taken on a further $1.5 billion, most of it to fund an expected “$1 billion burn” on original content this year. The company has admitted it will have to raise more debt later this year or early in 2017 to meet its expected cash needs.

The ratings agencies were not amused by the latest borrowings.

Standard & Poors downgraded Netflix bonds to “junk” status suggesting they are unsuitable for pension funds or anyone needing investment grade bonds. Moody’s also judged Netflix to be too risky for some classes of investors.

Hastings refuses to talk about ratings in the conventional sense of how many people are actually watching Netflix services. The only “ratings” he recognises are the number of subscribers.

Fair enough, subscribers equal revenue but the rate of subscriber growth in the US is falling back and America begins to look like a mature market for Netflix.

Real growth will have to come from the rest of the world but Hastings has admitted that it can take three years to break even in new territories because all the rights have to be bought up front before there are enough subscribers to cover the payments.

There are further questions about the longer-term security of their sources of library content. It was great when the rights owners could offload their libraries to this little streaming company. However most now realise that while Netflix money is nice they have helped to create a powerful competitor.

Both CBS and Fox have threatened to sell less of their content to Netflix in future while competition for content is pushing prices sky high.

At the same time Netflix is facing an intense battle for market share as, rather belatedly, rivals are getting their act together – rivals who range from HBO, Hulu and Amazon to CBS and Showtime.

Will Netflix be able to continue showing them all a clean pair of heels or will it be dragged back by the pursuing pack?

The biggest race Netflix is involved in is a battle with its own numbers. Can subscriber growth continue to outpace the growing level of debt generated by the push into original content?

It would only take a couple of disappointing quarters for the volatility in the Netflix share price to take on a new dimension and one that would puncture the current sense of invulnerability.

The other obvious dilemma is over the very nature of the Netflix business; something that was only absolutely clear when it was a low cost provider of masses of films and television programmes in the libraries of the major producers.

Correctly the Netflix team judged that to be unsustainable over the longer term and moved into high-end, high-ticket original drama from House of Card to the current hit Narcos.

If the company wants to make more than a small number of highly visible productions designed as much for marketing as profit, then the costs really start to rise.

As Netflix becomes a major producer in its own right with the attendant costs rather than a distributor of other people’s content, so it may also have to move away from cheap and cheerful subscription levels – one of the main reasons for success in the first place.

Netflix may yet enjoy the elevated status of Google, Facebook and Twitter but it is not there yet.

In the meantime its quarterly returns will come under increasing scrutiny.