Why Netflix Can't Seem to Miss

Score one for the algorithm crunchers over at Netflix (NASDAQ: NFLX  ) . After collecting just two months of viewer data since Hemlock Grove's April release, the streaming video company felt confident enough to approve a second season of the thriller.

Hemlock Grove didn't get anywhere near the critical praise that Netflix's original House of Cards attracted. But that didn't worry the company. It's the numbers that really matter. And by that measure, Hemlock Grove was a hit. It received more viewing worldwide on its opening weekend than House of Cards, and it did particularly well among young adults.

In other words, Netflix's algorithms were right.

The company analyzes terabytes of viewer information from its 30-plus million subscribers. We're talking everything from high-level data like watches, rewinds, and pauses, to granular bits, like which actors are popular with which types of viewers. As an executive from the company boasted to Wired, "We know what people watch on Netflix and we're able with a high degree of confidence to understand how big a likely audience is for a given show based on people's viewing habits."

Amazon.com (NASDAQ: AMZN  ) has taken a different approach to searching for hit shows. It put its Prime instant video series decisions up to a popular vote, asking viewers to help it decide which ones get green-lighted, and which get canceled. While that model has some advantages, it's a tough process for Amazon, as it involves piloting and development work. Still, Amazon's experiment won't really be put to the test until its first crop of shows begin to get released later this year.

But for now, Netflix's decision to double down on the show suggests the company's forecasting models are on point. And that means it's likely full speed ahead for spending on original series. Netflix expects these investment to run at a costly $200 million annually, or 10% of its total content spending.

The bad news for investors is that, because payments are front-loaded, Netflix's original series often need to be funded with debt. CEO Reed Hastings has explained: "As we expand Originals, they will consume cash. Since we are otherwise using domestic profits to fund international markets, we will raise capital as needed to fund the growth of Originals."

Expect Netflix's debt levels to continue to rise. But, as long as the new shows keep meeting or exceeding Netflix's projections, that spending should pay dividends in the form of higher net subscriber growth.

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