In its recent letter to shareholders, Netflix (NFLX -0.63%) shared a prediction for the future that could impact every major television and movie studio.
"As the competitive environment evolves, we may have increased opportunities to license more hit titles to complement our original programming," management wrote.
Netflix built itself on the back of licensing other media companies' content. And after the media companies saw the success of Netflix, they tried to copy it. The last four years have seen almost every major media giant launch its own streaming competitor with varying degrees of success. But they all have one thing in common: They're all losing massive amounts of money while Netflix is printing cash.
Netflix's competitors are finding out it's not as easy to extract additional value out of their own content as Netflix makes it look. And some might find it much more profitable to license their shows to Netflix instead of trying to sell their streaming service directly to consumers.
Image source: Getty Images.
Netflix made Suits the show of the summer
Netflix is uniquely capable of taking a show from being a minor success to a huge phenomenon.
It did this over a decade ago with shows like Breaking Bad, and it's doing it today with Suits. The latter, which originally aired on Comcast's (CMCSA 1.85%) USA Network from 2011 through 2019, became the most-watched title across film and television for three months starting in late June, according to Nielsen's data.
Before Netflix started licensing the show in June, both Comcast's Peacock streaming service and Amazon Prime carried the series. But only Netflix was able to take the series and "pop it right into the center of the culture in a huge way," as Netflix co-CEO Ted Sarandos said on the company's third-quarter earnings call.
In other words, Netflix is able to get a lot more value out of a licensed show than the media companies can get themselves.
That was clear three or four years ago when Netflix's latest round of competitors were just starting to launch. The streaming pioneer had 200 million subscribers and they had zero; of course it could get more value from competitors' content. But it's still true today after new streaming brands have become well established. And that speaks volumes of Netflix's ability to surface and distribute content to its 247 million global subscribers.
That leaves competing media companies in a bad spot.
Can legacy media companies make money in streaming?
Just about every media company has poured cash into building their respective streaming services over the past three or four years, racking up huge losses for investors.
Comcast, for example, saw its EBITDA losses for Peacock grow every year since its launch in July 2020. It's lost $2.9 billion on the streaming service over the last four quarters. That said, it's finally starting to show improvement (i.e., losses are getting smaller).
The big cost driver is content. And much of that content is licensed from itself. But for accounting purposes, it must mark that content expense at market rate. And the market rate is basically what it would be worth to Netflix (or another big streaming service). But as we've seen, Netflix is able to generate more value from a title than the original media company that produced it thanks to its scale, recommendation system, and the network effect it creates.
And while it might only be an expense on paper for these media companies, investors need to consider that it's a real opportunity cost. The company could license the content to Netflix and generate a profit.
Image source: Getty Images.
Meanwhile, in the current high interest rate environment, investors are putting pressure on every media company to start generating a profit from their streaming services. That's going to make it hard for many media specialists to retain the exclusive rights to their own content for their own streaming services and forego the potential high-margin revenue they could generate from licensing to Netflix.
That could result in many media companies hamstringing their own streaming services, and it could be a great opportunity for Netflix.
Media investors (outside of Netflix) ought to have a strong thesis for buying stock in a company other than "streaming will become a major source of profits in the future."
The opportunity for Netflix
If Netflix's prediction turns out to be correct, it could lead to a period of strong growth for the business.
While Netflix's original series is an important part of its strategy to drive new sign-ups for the service, licensed series drive a ton of engagement. Higher engagement leads to better subscriber retention. What's more, if Netflix subscribers can get some of the other streaming services' best content on Netflix, why would they bother switching to a competing service?
A return to more licensed content after a period of media companies pulling back could lead to a period of better net subscriber growth. That growth may be largely fueled by fewer losses instead of increased gross additions. And with 247 million global subscribers, even a few basis points of reduced subscriber churn can have a massive impact on Netflix's bottom line.
So even with its shares trading at a substantially higher price than its competitors based on just about every valuation measure, Netflix is proving to be the media stock to own.
