Netflix (NASDAQ: NFLX) is rightly credited with pioneering online video streaming. With more than a decade's experience behind it, the company is pulling all the right levers for continued success in the long term. At the end of the day, nothing matters more to an online streaming provider than its ability to attract and retain viewers. However, with the likes of Apple (NASDAQ: AAPL) and Disney (NYSE: DIS) now set to pose a serious challenge, will Netflix's big bets on original content pay off?
Image source: Netflix.
Impressive growth
In the last four years, Netflix's paid memberships grew at an average rate of 26%. In the first nine months of 2019, they grew 21% year over year. The company's revenues grew at an average rate of 30% in the last four years and at an average of 26% in the first three quarters of 2019. Netflix's strong and growing base of 158 million subscribers gives it an edge over other players in the market.
Additionally, Netflix has made impressive growth in international markets. It is already making inroads in the Latin America, Europe, Middle East, Africa, and Asia Pacific markets. To give this growth a further boost, Netflix is coming up with 130 seasons of original local-language content in the international markets.
Focus on content
One of the key factors contributing to Netflix's impressive subscriber growth is its focus on interesting content. While Netflix started streaming as only a content distributor, it understood the importance of producing its own content very early. The company realized that if online streaming is the future, it would only be a matter of time until other media companies entered the field themselves instead of licensing their movies and TV shows to Netflix. So with a library of original content, Netflix was preparing for eventualities such as Disney pulling removing its content from Netflix to stream on its own platform.
Netflix faces tough competition for content from the likes of Warner Media and Disney -- which owns movie franchises like Star Wars and Marvel and studios such as Pixar. While losing streaming rights for popular shows like Friends and The Office came as a blow to Netflix, it wasn't a bolt out of the blue. The company's decision to not pay a higher price for these shows stems from an analysis of their viewing value against the costs. Instead of clinging to old shows, Netflix aims to create more such blockbusters of its own.
Netflix spent around $15 billion on content in 2019, with the bulk of it on original programs. Moreover, the number of Oscar and Golden Globe nominations earned by Netflix reflects its intent to make quality content. Over the next few years, Netflix's library of original content should grow stronger.
High costs
Admittedly, the cost of producing its own shows has been high for Netflix. It has been spending far more cash than it earned over the past few years. That's because the company needs to spend up front during the content creation process. However, in the long run, creating its own content is less expensive, as the company works directly with the creators and saves on overhead. Moreover, it owns the rights to the content produced.
Netflix has been able to grow its revenues in emerging markets such as Latin America even at lower prices due to the huge and growing customer base in these markets. In the U.S., though there was a little churn in subscribers following the price increase in 2019, the move increased the company's revenues significantly. It shows that Netflix's pricing power in the U.S. market.
Netflix expects to remain cash-flow negative over the next several years. However, it expects its free cash flow to start improving in 2020 thanks to a steady rise in its operating margin from 10% in 2018 to 13% in 2019 and 16% in 2020. Netflix's big and growing subscriber base should continue to help it in improving revenues as well as margins.
While original programming is a key focus, Netflix understands the importance of streaming people's favorite shows and movies, so it continues to pay license fees for properties like Seinfeld. Overall, the company intends to continue offering its viewers a variety of quality content across genres.
Building momentum
It's not going to be smooth sailing for Netflix. But with its original programming strategy, huge subscriber base, and growing international memberships, Netflix looks set to face competition head on. Based on its success so far, Netflix's differentiated content strategy should allow it to not only grow its subscriber base but also exercise pricing power and ultimately grow revenues.
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Rekha Khandelwal has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple, Netflix, and Walt Disney and recommends the following options: long January 2021 $60 calls on Walt Disney and short April 2020 $135 calls on Walt Disney. The Motley Fool has a disclosure policy.
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