Netflix plows money back into content – investors grin and bear it

Netflix’s original content strategy is clearly paying off, and so it should at an annual spend of $6.6 billion, with an additional $16 billion set to be siphoned into original investments over the next five years. Yet, despite the celebrations, there has been some concerned noises coming from the investor and analyst communities that prolonged investment in original content at this scale will mean Netflix will be recording negative free cash flows for years to come, with little return. The shareholders would have Netflix convert its original content investments into cash cows – but that could be potentially disastrous.

Netflix’s share price soared to over $183 for the first time after its record breaking results were released this week. The company smashed through the 100 million subscriber milestone in the quarter, adding 5.2 million to beat its own expectations of 3 million – in a quarter once again spearheaded by impressive international growth.

In a quarter widely considered to be Netflix’s most successful ever and awash with newly accomplished feats, the most significant of all was perhaps that its international subscriber base overtook its US base for the first time. It added 4.14 million abroad to bring its international subs to 52.03 million, compared to 51.93 million in the US, where it saw growth of 1.07 million – totaling 104 million worldwide.

Revenue for the quarter rose 32.3% to $2.79 billion, with operating income up $58 million year on year to $128 million in the period. However, our previously mentioned concerns are arising from its international financials, where Netflix had second quarter revenue of $1.17 billion but made a loss of $13 million due to continual investment in content. Our own assessment is that in order to conquer Asia, Netflix will need even larger investments in Asian content, and lower pricing.

The second quarter is traditionally a tricky period, but Netflix managed to stem international losses from $69 million in the same period last year, and has an outlook of making $30 million profit in the next quarter. The first quarter of this year was more successful for Netflix overseas than the second, pulling in profit of $43 million.

Having said that, we believe the investor concerns will be short-lived, as its presence in many territories is still relatively recent. Also, we don’t normally hype up awards as anything to shout about in the media and tech worlds, but 91 Emmy nominations for 27 Netflix titles, as nominated by the Television Academy last week, shows it must be doing something right.

A second point of contention which we have highlighted on multiple occasions, but is worth reiterating this week, is the company’s long-term strategy in Asia Pacific. We think Netflix’s plans for launching original productions across Asia Pacific is the most significant of them all – a make or break opportunity.

The self-proclaimed “learning machine” still has much to learn in this fragmented and diverse region, and CEO Reed Hastings conceded that fact on the company’s earnings call this week. “We’re really expanding a lot in India and Japan, we’re figuring it out market by market, but Asia is very unique and very large, so we see a huge opportunity for us over the next few years – all of us spending more time there and investing more. We saw great success this quarter with Okja,” said Hastings.

CCO Ted Sarandos added to this, “Okja is directed by Bong Joon-o, the most celebrated director in Korea, a huge star, but the movie itself is one of the most ambitious productions ever attempted in Korea. It helped attract new subscribers and bring a brand halo to Netflix that it is great content worth paying for across pockets of Asia, with many hearing about Netflix for the first time through Okja. So there’s still a lot of work to do.”

On the tech front, Hastings said, “We’ve had great success in mobile. We’re continuing to get better and better at encoding efficiently, so that it takes less and less network bandwidth. That’s paralleling the improvements that YouTube and others are doing to make video a natural part of mobile phones.”

Netflix premiered 14 new seasons of global original series in the last quarter, as well as 13 original comedy specials, 6 original documentaries, 2 original documentary series, 9 original feature films and 7 seasons of original series for kids – with plenty more on the pipeline.

“We strive to be bold in our programming choices and financially disciplined, so we can keep being bold. Every show has passionate fans and committed talent striving for excellence. Sometimes those shows don’t attract as many viewers as we had hoped, compared to our other content. As much as we dislike ending a series early, it consoles us that it frees up investment for another new show, or two. We are programming to please our members and we keep that as our guiding light,” wrote Hastings in a letter to investors.