Is Netflix’s Investment In Original Programming Paying Off?

-17.11%
Downside
605
Market
502
Trefis
NFLX: Netflix logo
NFLX
Netflix

In a recent Morgan Stanley survey, Netflix (NASDAQ:NFLX) has  been voted as the “best” original content media company compared to any other premium TV or internet-video subscription service. HBO had occupied this position for several years, but is now in second place by a large margin. Of the respondents to the survey, 29% voted for Netflix as the best in original programming, with HBO getting only 18% of the votes. Amazon was in the 4-5% range.  THe appeal of this content to Netflix subscribers should not be underestimated.  Netflix will be increasing its subscription charges for a significant number of its users,  as their two year grace period ends. We believe, though, that original programming is ensuring that users are hooked to Netflix despite the increase. (Read  Can An Increase In Subscription Rates Impact Netflix’s Subscriber Growth).  In fact, a survey by investment bank SG Cowen revealed that 58% of subscribers pay for Netflix for its original shows. This number is up from 37% in December 2014, indicating the popularity of its shows. Netflix’s content acquisition spending has been highest among competitors in recent years and we believe this investment is paying off, enabling the company to retain and increase its subscriber base.

See our complete analysis for Netflix

Competition Intensifying As Media Companies Increase Content Spending

Relevant Articles
  1. Netflix On A Roll As It Benefits From Paid Sharing And Ads. Is The Stock Undervalued At $610?
  2. Up 50% Over Last Year, Will Q4 Earnings Drive Netflix Stock Higher?
  3. Will Netflix Stock Rally 40% To Return To Pre-Inflation Shock Highs?
  4. How Will The Password Sharing Crackdown Help Netflix Q3 Results?
  5. Will Netflix Stock Return To Pre-Inflation Shock Highs Of Over $650?
  6. The Big Password Sharing Crackdown Will Bolster Netflix’s Q2 Results

Netflix has been focusing on acquiring ‘exclusive’ content for its subscribers to maintain a competitive edge. Reports suggest that the company has recently entered into a deal with BBC to acquire rights to the new series of Top Gear.  However, competition in this space is intensifying. Amazon is reportedly working with Clarkson & Co. on a new motoring show that will debut on its Prime Video this year, competing directly with Top Gear. While Netflix is likely to spend $5 billion on non-sports original content in 2016, other media companies are not far behind. Time Warner is set to spend $4.5 billion on original content, while this figure for Fox and Viacom is estimated at $ 3.8 billion for 2016.  While these increases in programming costs will impact margins of media companies  in the short term, not all will be affected to the same degree.  Netflix’s strong subscriber base and user growth  ensures that the company should be able to increase spend on original programming without taking a significant hit on its margins, especially given the effective price increase as free trials end.

We estimate Netflix’s U.S subscribers to increase steadily from around 50 million in 2016 to more than 60 million by the end of our forecast period.

As Netflix’s subscriber base grows, the company will gain operating leverage, in our view, and  be able to reduce its marketing expenses. Thus, we estimate its domestic streaming contribution margin to increase gradually from nearly 37% in 2016 to around 43% by the end of our forecast period.

However, as competition intensifies and Netflix’s original content spending increases significantly, a pressure on margins could lead to a downside to our price estimate. If the domestic streaming contribution margin remains steady around 35% over our forecast period, there can be a 10% downside to our price estimate.

We believe Netflix’s focus on high quality, exclusive and original content is paying off, with subscribers willing to continue their Netflix subscription primarily due to original programming. As the company tries to retain its competitive edge in an increasingly crowded market, it will have to continue to focus on both content and profitability as the key levers for its valuation in future.

View Interactive Institutional Research (Powered by Trefis):

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap

More Trefis Research