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Netflix Inc Bears Just Don't Get It

By Jeremy Bowman - Sep 28, 2015 at 3:00PM

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Another sell recommendation was slapped on the leading streamer, but the logic comes up short.

Bashing Netflix Inc (NFLX 4.15%) stock is getting popular.

Just a few weeks after Netflix bears heralded the increasing competition from Hulu,, and Apple, Evercore ISI's Ken Sena added his name to the list of streaming player-haters, reiterating a Sell rating with a screed predicting Netflix's downfall.

Sena sang a familiar tune, claiming that as the streaming market matured Netflix would lose its competitive advantage and become just another hustler, and he trotted out numbers to back up his thesis.

His sell recommendation focused on Netflix underpaying for content versus linear broadcasters. According to his math, the red-lettered streamer pays just $0.07 for every hour consumed by its subscribers, based on streaming content amortization of $750 million in the first quarter divided by 10 billion hours, while network TV providers pay $0.26 per hour.

The numbers underlying Sena's argument may be accurate, but his method and conclusion are flawed for a number of reasons. 

Lower costs are a sign of market power, not weakness
Wal-Mart grew to dominate retail using its economies of scale to drive down costs and offer the lowest prices. Amazon and Costco have since horned in on Wal-Mart leadership by disrupting that model with e-commerce and warehouse retail. In digital music, Apple was able to negotiate a price of $0.99/song on iTunes, revolutionizing that market. In a negotiated market, costs aren't equal among buyers. 

Sena assumes that costs should be based on viewership, but there's no reason that should be the case. The main reason why Netflix's content costs are so much lower than those of its traditional rivals is that its service is much more popular. Netflix's 65 million worldwide members is a credit to the service itself, not to the content providers whose product is available through other channels. Therefore, it's unrealistic for content providers to charge Netflix for its huge subscriber base. If anything, that growing base should make Netflix a more attractive partner for well-known creators.

Originals are an increasing part of Netflix's empire
Sena's position is based on what Netflix is paying for content, but the company's value proposition is increasingly based on original productions. Since Netflix doesn't release audience figures for individual shows, we don't know how much of its viewership is devoted to originals -- but that percentage appears to be considerable based on the popularity of shows like House of Cards and Orange is the New Black. As Netflix invests more in originals, the price tag of licensed content becomes less relevant. We saw the latest manifestation of this strategy when Netflix said its partnership with Epix would expire at the end of this month. Management is increasingly focused on originals and exclusive content, echoing Sena's argument that it must work to differentiate itself.

Streaming is taking over, and it's creating a boom in TV 
With Netflix growing its subscriber base by about 6 million domestic households per year and cable and satellite TV losing subscribers, it's clear that Internet TV is on its way to replacing linear TV, making cost comparisons between the two technologies suspect. But the emergence of Netflix and other streaming providers has also had another distinct impact on television. The quantity and quality is better than ever, bring TV into another Golden Age.

With that, the number of new shows has surged. Some TV execs believe there is simply too much competition for their content to shine through and generate enough buzz to drive a significant audience. 

The number of scripted shows is expected to pass 400 this year, up double from 211 in 2009. It's a remarkable bounty, and one that would not have been possible without Netflix streaming. While that news may be frustrating for content creators, it's great for Netflix. The improving quality and excess supply gives viewers all the more reason to sign up, and oversupply should, according to economics, lower prices, all things being equal. 

The changing dynamics also favor Netflix's "binge viewing" platform rather than traditional TV, which counts on advertising revenue and therefore real-time viewers to support its model. And as the recent Emmy Awards showed, the best content is found on the streaming services, including HBO Now.

Haters gonna hate
Finally, Sena argued that content creators will go directly for the viewer, bypassing the need for an aggregator like Netflix -- but as we've seen in music streaming and e-commerce, the power of a brand and a single platform is strong. Viewers prefer a single-fee, one-stop shop for their entertainment and other purchases, and while some will add complementary streaming services, it's unlikely that content creators alone will draw Netflix members away. The company has more data on viewer habits than any of its rivals, and has made significant inroads for its service across a number of platforms, even announcing recently that it will be available through virtual reality devices. 

The service remains overwhelmingly popular -- a recent survey showed more than 90% of subscribers plan to continue. It's growing steadily, and continues to improve. What bears like Sena don't understand is that those factors bode well for the company in nearly every possible future scenario, and that power also creates price elasticity. Even if content costs go up, it's likely that Netflix can pass on some price hikes to its subscribers, as it is still a cheaper option that many competing services.

At 65 million subscribers and growing, it's clear that the streaming phenom is no pretender.


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Netflix, Inc. Stock Quote
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Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
$440.11 (0.55%) $2.40, Inc. Stock Quote, Inc.
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