Netflix leads SVoD brigade sprinting past traditional pay TV

Netflix smashed streaming records again in its latest set of results, naturally followed by industry noises of saturation nearing. At its current run rate, that could not look further from the truth. US domination is almost done; the next chapter for Netflix is all about international content, and not just distributing big budget Hollywood and homemade titles overseas, but producing original content tailor made for international audiences. We think this could eventually become a two-way street, distributing international content back to the US, resulting in reduced production costs, a disrupted and disheveled Hollywood, and much higher margins for Netflix.

Subscribers arrived in droves over the holiday period, adding 6.36 million international and 2 million domestic streamers – to end 2017 on 117.6 million total memberships.

Critically, the US market has reached a turning point. As Netflix climbed to 54.75 million US subscribers, the total US pay TV market dropped to 93.8 million subscribers, according to Kagan and S&P Global Market Intelligence data – closing the gap from 90.6 million subscribers between Netflix and total pay TV ten years ago, to just 39 million today.

When we take into account the top 9 US skinny bundles, accounting for around 10.2 million subscribers according to recent numbers, that gap closes to 28.8 million. Adding some figures out this week from CNBC, stating Hulu’s vMVPD service now has 450,000 subscribers, rising from around 150,000 last May, the gap closes even further to around 25.5 million.

Amazon Prime has around 70 million households in the US, of which an estimated 30% to 40% use the service for regularly streaming video content, so as many as 28 million users. Including these Prime Video viewers, the balance of OTT video to pay TV subscribers is neck and neck. There are smaller, niche streaming services, as well as viewers subscribing to one-off events such as live sports or movies, which, when combined, probably nudges the total number of OTT video households over total pay TV households in the US. Our point is the market has turned a corner and will never recover.

Next up is the trickier task of international dominance. Addressing critical reviews to Bright, the $90 million budget movie Netflix rolled out last month, CEO Reed Hastings highlighted the company’s roadmap in this week’s earnings call, “The critics are pretty disconnected from the mass appeal, especially remembering that we’re moving with the international at this point and most of those critical reviews you read are English language and usually just US.”

Netflix’s international expansion effort saw marketing costs soar 25% annually to $224.1 million for Q4 2017, and $724.7 million for the year, an increase of 19%. International operations contributed a loss of $308.5 million in 2016, but the tables turned in 2017, bringing in profit of $226.6 million.

Current content assets are valued at $4.3 billion, rising from $3.7 billion at the end of 2016. Additions to streaming content assets cost Netflix just under $2.5 billion in the fourth quarter, increasing by $400 million from Q4 2016.

Investors have been critical of content spend by Netflix, and the latest results did little to quell anxiety levels, taking a $39 million hit from unused content. Yet Netflix stands firm and announced plans to spend between $7.5 billion and $8 billion on content in 2018. Hastings and his team have every faith that these huge content investments will pay off, and we are inclined to agree.

The acquisition of 21st Century Fox by Disney, along with the arrival of a direct to consumer Disney streaming service, should be of some concern to Netflix. However, Hastings told investors, “We don’t see it as a threat to us any more than Hulu has been, but it’s a great opportunity for Disney. And will it trigger a wave of consolidation? That’s possible.”

Even CBS bent the knee to Netflix recently, licensing Star Trek to Netflix for international distribution. “CBS is taking a middle road where it’s got All Access with a bunch of shows. Think of it as an evolving mix. If we can monetize content really well, then people will sell it to us because we can pay them, and that’s ultimately the core economic driver,” said Hastings.

The company posted revenues of almost $3.3 billion for the fourth quarter of 2017, rising from just under $2.5 billion for the same period in 2016, bringing Netflix’s total annual revenues to $11.7 billion, bettering its 2016 performance by over $2.8 billion. Operating income for the last quarter came in at $245 million, up $91.3 million year on year, totaling $838.7 million for the year – an impressive jump of 120%.

“Many investors were quite reasonably concerned about our international expansion; would we be popular in LatAm or Europe or Asia? That’s a reasonable concern. Many companies have issues there. But we’re pretty focused on the great execution of this narrow focus of what we do, not getting distracted by everybody else,” said Hastings.

Netflix’s stock price spiked 13% as of writing, with a market cap of $108.3 billion – this is a valuation which will inflate, and pretty soon reach the point where Netflix cannot be acquired, not even by Apple.