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Netflix (NASDAQ:NFLX) is back. Remember when the proverbial sky was falling vis a vis the prospects of the streamer that started it all?
Get ready for more tug-of-war price action as the streaming wars continue.
Undoubtedly, Netflix will sometimes be up and sometimes down; one can say that about any stock. But the long-term potential is something I still see in this company.
However, I do want more progress on a true theatrical strategy, and management’s recent earnings call makes me wonder (fear?) if the company may be too distracted by advertising.
Yes, it’s important – an ad-supported option is part of a new business model brought on by an inflection point in Netflix’s journey toward maturation.
But the company must look at the multiplex as a new revenue stream with which it can both diversify and grow the top line. And cross-promote, of course.
I want to take a brief look at where the movie strategy may be post Netflix’s recent earnings report, thus offering a continuation and an update on my thoughts concerning this topic.
The Third Quarter – Where Does The Multiplex Fit In?
Without a doubt, the big news is the reversal of fortune Netflix recently experienced. Wall Street does not want to see subscriber declines as the streaming wars become more competitive, so recent stats were quite welcome. The company had stated it would add a million subscribers during its fiscal Q3; instead, it did much better at 2.41 million net sign-ups. Yes, I suspect it may have been partially (if not totally) a case of under-promise-over-deliver, but that’s okay… I’ll take it. I’ll take too the new guidance of 4.5 million net-additions in Q4. Streaming episodic content is obviously assisting here.
But I want a true theatrical strategy, one that sees a division specifically set up to exploit box-office grosses and incubate new intellectual properties. And I’m not sure if the company wants to explore this option as aggressively as it could. This article points out that comments from Ted Sarandos during the conference call didn’t exactly express a ringing endorsement of producing movies to, first and foremost, make an ROI on a slate budget; rather, they seemed to want to put the recent Knives Out announcement in perspective, with streaming still at the center, as well as all points around it, as far as Netflix is concerned.
The Knives Out sequel for which Netflix struck a deal to air is basically doing the following: it will be placed in theaters near the latter part of November for a week and will then be broadcast on the service about a month later in December. I’ve read that it’s possible it might last more than a week if returns are good, but that is unclear to me at the moment, so let’s just count on a week, with 600 screens playing it.
Well…I guess that’s good for a start. Problem is, does Netflix look at this as a start, or perhaps as something meant only to appease talent, or to get an Oscar-qualification run, or simply to advertise the service? I would say first and foremost that this is a talent-driven decision, especially considering that exhibitors are notoriously skeptical of being in business with new-generation distribution models that are collapsing legacy windows left and right.
As Netflix moves further along its corporate timeline, subscriber growth will ebb and flow, and the conundrum of consumers trading down to ad-supported tiers for economic reasons also threatens to rock the stock. It’s not a problem yet, obviously, as the ad tier hasn’t launched, but a theatrical slate would help to alleviate such concerns. Plus, the act of consumers resonating between one streamer and another, its own species of churn, will affect subscriber levels in the near future, which is yet another reason for increased revenue options.
There are complications, though. Everyone is amazed at the window in place with the Knives sequel, as they should be, since it was a difficult, time-consuming deal to hammer out; on the other hand, a one-week run followed by a window until it hits Netflix, plus the fact that the film will only be on 600 screens, a very small footprint, says to me that Netflix wants to be cautious about triggering any higher backend payments. We’ve all seen what Scarlett Johansson thought about streaming versus silver-screen with her battle against Disney (DIS). If Netflix scaled this up any higher, would there be similar issues? Yes, I said this was talent-driven, but probably only to the point of talent being comfortable that this type of smaller placement satisfies the desire for being in the multiplex, and all the glamor that goes along with that privilege, while simultaneously not making the agents behind the deal believe they under-quoted themselves when the Knives IP was purchased for nearly $470 million (although, it’s been said that director Rian Johnson and two other primary participants stand to make $100 million from the deal). Such is the economic rapids that must be navigated in Hollywood.
The company scored its recent subscriber gains presumably in part from some recent hit content, including Ryan Murphy’s portfolio of programming. It’s interesting to recall, only very recently, that there was some media press on whether or not Murphy’s content was living up to its potential given the enormous cost of acquiring his talents; now, though, he’s seemingly on top with popular material such as The Watcher. This makes for another complication: co-CEOs Reed Hastings and Ted Sarandos probably have a lot of their mindshare tied up with mining the data from these latest hits, and along with the Stranger Things franchise, could they be blamed for being somewhat distracted away from the concept of celluloid? Episodic and streaming-exclusive feature-length are working right now in the marketplace: why not keep capital allocation focused there? That’s how the streamer started, and that’s what Wall Street previously enjoyed about recommending the shares: before roadblocks in subscriber gains popped up, Netflix offered a pure play on subscription-video-on-demand and avoided the dreaded media-conglomerate undervaluation because of the latter’s legacy linear structures and broader entertainment ecosystems (i.e., investments in broadcasters, cable channels, merchandising, multiplex, theme parks).
Here’s why the company should think differently: a theatrical strategy offers the opportunity to incubate potential franchises at a gradient of budgetary values and compensation structures – it doesn’t always have to be half-a-billion bucks to buy out the rights to a sequel. The company could use $50 million in seed money to produce ten $5 million pictures and see what sticks in the marketplace, just as one example. It could also produce its own tentpole superhero films, perhaps allowing some of the major talent to take a little extra from the theatrical backend to compensate for streaming exclusivity.
There’s no question the Ryan-Murphy-Shonda-Rhimes-type overall deals are important; Netflix, however, has episodic amply covered. Theatrical could jumpstart a whole new revenue stream, valuable on its own, even outside of cross-promotion effects. It would offer a way too of offsetting costs of development for major films (that might sound somewhat contradictory given what I said about potential increasing backend demands, but presuming talent increases its ask anyway over time, even for streaming buyouts, then it still makes sense to get into theaters). And whereas the company wants to ensure its streaming service gets the best bang for its buck, if a new IP starts out in theaters, there is always the flexibility of continuing the franchise streaming-only if the data suggests it would be the best way of proceeding (look at how Disney handles some of its streaming-versus-silver-screen decisions, with some sequels/reboots placed on D+ only).
From the conference call, Ted Sarandos, in response to a question from host/analyst Douglas Anmuth, who wanted to know why the Knives sequel wasn’t receiving a longer booking, stated:
Well, first, I’ll tell you, we’re in the business of entertaining our members with Netflix movies on Netflix. So that’s where we focus all of our energy and most of our spend.
So I would look at this as, just another way to build anticipation for the film, and build buzz and reputation for the film ahead of its Netflix release. There’s all kinds of debates all the time back and forth, but there is no question internally that we make our movies for our members, and we really want them to watch on Netflix.”
Sarandos mentioned the use of film festivals to display the company’s product, as well as the tendency of the market to watch movies at home.
Well…this is not what I want to hear from Sarandos. I want enthusiasm for multiplex screens. Home screens are great and valuable; but the multiplex…that needs to be put through the Netflix business model as well.
The Stock
Netflix isn’t going anywhere; it’s still the streamer to beat, even with all the competition. The company has 223 million subscribers, and the advertising-tier should help to keep that steadily climbing.
The stock still rates as very expensive based on SA’s metrics analysis.
Shares have bounced off the 52-week low of roughly $160, trading at the time of this writing at nearly $290. Okay, though, that is quite a distance from the $700 high!
Given what I believe is a streaming company that still has yet to reach its full potential with multiplex distribution and merchandising, I’d argue now may be a good time to take a look at the company. Bear markets tend to offer great entry points for growth stocks.
Keep in mind, too, that cash flow is improving. Free cash flow in Q3 was positive at $470 million, and expectations are for $1 billion in free cash to be generated by the end of the fiscal year. Further, that $1 billion should be bested next year, according to management.
We’ve got improving cash flow, a better subscriber outlook, a depressed stock price during a down market period, and shares that are expensive based on certain ratios.
Fair enough. Best practice here is to be opportunistic – don’t rush in, look for pullbacks, average in over time. Hold for the long term. Nothing wrong with trading Netflix, but for most, this would be an ideal way of approaching the company…as an investment.
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