Purchasing the digital streaming rights for television shows and movies is not as simple as it was five years ago. Back then, Netflix (NASDAQ:NFLX) was about the only company spending serious money on digital streaming rights. Now, it faces serious competitors in the space. One of the largest is Amazon.com (NASDAQ:AMZN), which has ramped up spending on content in 2014.
What used to be a buyer's market for Netflix is quickly turning into a bidding war.
A look at content obligations
Between the end of 2010 and the third quarter of 2014, Netflix's content obligations ballooned from $1.3 billion to $8.9 billion. Of course, Netflix now operates in about 40 more countries than it did in 2010, and it's closing in on three times the number of subscribers.
Many believe content obligations will come under control for Netflix because it's capable of controlling how much it spends on new content. And that's true to a certain degree. If networks ask too much to license new shows or relicense old ones, Netflix can walk away. But it's unlikely those networks will come back to Netflix with a lower asking price. There are just too many other options.
Amazon, in particular, has been willing to spend money where Netflix has not.
When Netflix ended its agreement with Viacom last May, it planned to work out deals with the media company to license individual shows. Just days after the Netflix-Viacom deal expired, Amazon and Viacom agreed to a two-year deal for a bundle of about 4,000 TV episodes worth over $200 million.
Amazon's "unconditional purchase obligations" for digital content have more than doubled over the last two years. Amazon has already committed to $475 million in content deals for 2015, and it has another $714 million in commitments next year that include multi-year content licenses. With Amazon's penchant to give investors as little information as necessary, we know its total content obligations sit somewhere between $1.47 billion and $4.22 billion.
While Amazon's content license costs are far lower than Netflix's, the company has shown a willingness to spend more on content as Prime memberships grow.
Who will buy more content?
Netflix's continued growth relies primarily on maintaining an attractive content library. That fact alone will push it to spend as much as it needs to continue growing its subscriber base for the foreseeable future. If it needs to tap the debt market further or issue additional shares of stock in a secondary offering, so be it. Both of those actions would likely have negative short-term impacts on the stock price.
Amazon's revenues and Prime memberships, on the other hand, don't depend solely on its content library. Amazon is providing customers with more and more reasons to sign up for Prime that often cost it less than new video content, which means Amazon is unlikely to ever spend as much as Netflix to secure content rights.
Even if Amazon doesn't spend as much as Netflix for video content, its presence in the market gives content owners more leverage when dealing with Netflix. Again, Amazon has shown that it's willing to spend more on content as its Prime memberships increase. Amazon's content purchase obligations for 2016 are already closing in on 2015 commitments as of the end of the third quarter.
At the end of last quarter, Amazon's cash pile stood at $5.25 billion. Netflix has just $1.18 billion in cash on hand and has generated negative free cash flow over the past 12 months. What's more Amazon's fourth quarter typically generates huge amounts of cash for the company, so it wouldn't be surprising if it ended 2014 with close to $10 billion in cash.
The asking price for content is rising because of a number of factors. Amazon is much better equipped to meet the asking price than Netflix, but Netflix should be more willing to spend than Amazon. That willingness to spend will cause its content costs to continue climbing for the foreseeable future.
Adam Levy owns shares of Amazon.com and Apple. The Motley Fool recommends and owns shares of Amazon.com, Apple, Google (A and C shares), and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.