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Netflix Is Still Too Dependent on Licensed Content

GuruFocus.com
·4 min read

- By John Engle

Netflix Inc. (NASDAQ:NFLX) has transformed the entertainment landscape, bringing streaming media into the mainstream. That transformation has proven expensive, as the company licenses vast amounts of content to stream on its platform.

The company's content licensing habit has grown increasingly expensive in recent years. With competition intensifying, that problem will likely only get worse.


Costs continue to escalate

At times, the pace of content license price escalation seems to come as a surprise even to senior management. During a quarterly earnings call in October 2019, for example, CEO Reed Hastings seemed to be under the impression that content costs had risen by approximately 30% to 50% over the past five years. Chief Content Officer Theodore Sarandos swiftly corrected Hastings, however, stating that the licensing cost of the most popular series had risen 30% in the previous year alone.

Licensed content continues to make up a large part of Netflix's expenses. As Investopedia's Brian Beers explained in August, this is reflected in the streaming media company's balance sheet:


"Securing licensing agreements is one of the biggest expenses for Netflix. At the end of 2019, Netflix had $24.5 billion of content assets on its balance sheet, up from $20.1 billion the year before. Of this, licensed content accounted for $14.7 billion in 2019 and $14.08 billion in 2018. The company is devoting more of its financial resources to developing its own TV programs and film. It had $9.8 billion in produced content in 2019, up from $6 billion in 2018."



While Netflix has continued to invest heavily in its original content library, it is still spending substantially more on licensed content from other producers, studios and media companies. That is not likely to change anytime soon, meaning that Netflix will continue to license content that is ever more costly to obtain.

The streaming wars intensify

Even if Netflix had the financial wherewithal to consistently outbid its rivals, a growing proportion of top-shelf streaming content is no longer in the licensed media market at all, instead finding new homes on rival streaming services. The Walt Disney Co. (NYSE:DIS) has made a big bet on streaming with its Disney+, Hulu and ESPN+ platforms, as have other rivals.

Rivals' streaming efforts have only intensified following the outbreak of the Covid-19 pandemic, which has disrupted traditional distribution channels, as Bloomberg's Tara Lachapelle observed on Dec. 14:


"Until now, major studios had treaded carefully in their relationships with theater operators because the industry was too important. After all, Disney took a one-third share of the $11.3 billion box office in 2019, while AT&T Inc.'s Warner Bros., Sony and Comcast Corp.'s Universal split another third. But in the wake of Covid, the companies seem to be giving up on cinemas in some ways. Even with a vaccine, theater patronage may never bounce back to the level needed for any entertainment giant to justify prioritizing theaters over streaming. Warner said this month that each film it puts in cinemas next year will immediately become available on the $15-a-month HBO Max app for one month."



With more streaming services on the market, Netflix faces both greater competition for top-tier content licenses and the loss of content to their owners' platforms. That is a problem since Netflix's original content is rarely its most popular. According to The Entertainment Strategy Guy, a widely followed media analyst, just four licensed shows account for a whopping 6% of all Netflix views in the U.S.

My verdict

Netflix has won over a host of enthusiastic investors with a story of long-term streaming media dominance. Unfortunately, competition is only intensifying in an ever more fragmented streaming market. While Netflix remains the top dog in streaming for now, the high cost of licensing content, in addition to inevitable losses of top-tier content to other services, will make it hard to sustain its position.

In my assessment, Netflix is unlikely to be able to overcome the fundamental challenges and disruptions that are transforming the streaming industry. Over time, competition is likely to eat into Netflix's market share and its share price.

Disclosure: No positions.

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This article first appeared on GuruFocus.