Netflix business model in question as big boys join the game

January 29, 2019 13:22
Netflix is burning a lot of cash to beef up its content and boost subscriber numbers. Industry watchers wonder how long the expensive strategy can be sustained. Photo: Reuters

Streaming services giant Netflix has successfully boosted its subscriber numbers ahead of projections, yet its revenue growth clip has been trending down.

Revenue growth dropped to 27.4 percent in the last quarter of 2018, from a 40.4 percent pace in the first quarter. Company management expects the revenue growth to ease further to 20 percent in the current quarter.

To attract customers, Netflix has spent heavily on making blockbuster original hits like House of Cards, The Crown and Bird Box.

But the problem is you can never guarantee a show will become a big hit. Another problem is, viewers still like other non-Netflix programs and Netflix has to pay hefty copyright fees to other firms.

For example, the popular sitcom Friends is one of the top 10 popular shows on Netflix of all time.

Netflix announced earlier that Friends won't be available soon. That made its users unhappy. As a result, the company decided to pay US$100 million to extend the streaming contract for the sitcom for another year.

No matter if it’s producing more own content or paying more for copyright, Netflix has to keep burning cash. And it’s getting worse.

Netflix reported negative net free cash flow of US$2.5 billion last year despite earnings of US$1.2 billion.

The cash burn makes sense if Netflix can build a strong business moat and recoup the investment spending in the long run.

But the competitive landscape is changing against Netflix.

AT&T got the green light to acquire Times Warner for US$85 billion in June last year, a deal that enables AT&T to transform itself into a media giant. And Disney acquired 21st Century Fox’s film and television assets last year in a deal worth US$71.3 billion. These big boys are seriously pushing into streaming business.

But perhaps the biggest competition is from YouTube, which does not need to burn cash to produce content. Instead, it gets massive advertising revenue, and most content is free for viewers.

Netflix announced a significant price increase recently to ease the financial burden. But the relief is insignificant compared to its net debt of US$6.6 billion. Net debt-to-equity ratio stands at a staggering 110 percent.

The company can’t burn cash for ever.

But Netflix is facing a dilemma. If it stops its heavy investment in original content, cash flow would improve, but subscriber addition may slow down.

Instead, if it keeps burning cash to compete with other big players, who can tell if Netflix can ever recover its investments?

This article appeared in the Hong Kong Economic Journal on Jan 28

Translation by Julie Zhu

[Chinese version 中文版]

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Columnist at the Hong Kong Economic Journal