Is Netflix Spending Too Much On Content

By Ross Gerber

Earlier this month, Netflix issued a press release announcing that it had acquired Seth Rogen, the actual person, not the rights to his past work or an agreement to own a series of his upcoming projects. The comedian even responded to inquiries noting that he was a ‘wholly owned subsidiary of Netflix.’

As it turns out, the announcement was a stunt, part of a promotional effort surrounding Rogen’s comedy special, “Hilarity for Charity,” a fundraiser that was released exclusively on Netflix April 6. Though it was a gag, it contained a kernel of truth in alluding to Netflix’s willingness to spend on anything and everything.

The company spent over $6 billion on content in 2017 and has plans to spend up to $8 billion this year. Thus far, this strategy has paid off, with Netflix acquiring troves of valuable content, which each quarter has translated into billions in revenue and millions of new subscribers. This, along with the perception that Netflix is the primary beneficiary of the ongoing cord-cutting revolution, has sent its valuation soaring.
Indeed, the stock is up more than 140 percent over the last year, even as there is a strong case to be made that the current price is far too high for a company that doesn’t generate much profit, a point that brings us back to Netflix’s spending: When will the company start to rein it in?

There’s a theory that there’s a finite number of good shows and movies to come out of Hollywood each year. For our purposes, let’s assume that number is 30. According to this theory, it doesn’t matter whether studios spend a combined $5 billion, $10 billion or even $50 billion. In each case, there will be only 30 movies and shows worth seeing.
In other words, there are only so many creative talented people and good projects in show business and no amount of money will change that dynamic. If this theory is true, additional spending doesn’t yield better content, only more losses, which means Netflix’s outsized content budget could soon be a more profound liability than even its harshest critics contend.

That’s because the company doesn’t write down losses for poor performing content. When Disney, for example, produces a flop such as Mars Needs Moms, which lost over $140 million in 2011, it will typically write down those losses during that same year, partly because it helps the company slash its tax bill. In Netflix's case, they don't attribute and direct revenue to any project so they can contend they don't really lose money on a single project. We know this isn't reality.

Focused more on revenue and subscriber growth, Netflix does not do that. It instead amortizes costs over the course of many years, meaning it’s hard to know what portion of its content library has value, a point exasperated by the fact that accurately tracking streaming ratings has proved difficult and that Netflix refuses to reveal viewership numbers for individual shows.

For now, the current strategy of spending lavishly is paying off, resulting in a near monopoly of highly prized talent, underscored by the recent agreements with Shonda Rhimes and Ryan Murphy. Clearly, this approach is not sustainable. The big question going forward, therefore, will be when and how quickly Netflix pares back or levels off spending and transitions to a profitable business.

If it is, in fact, masking deep content losses through its accounting practices, while at the same time continuing to spend profligately, there will soon be a reckoning, much like a bank that has a bunch of toxic mortgages on its books. We all know how that worked out. For now, Netflix seems to be hitting it out of the park while doing a good job mitigating losses. We've also seen a wave of cancellations of poor performing shows. If they can maintain their discipline, despite great competition from very deep pocketed rivals, Netflix will continue to dominate the global streaming video market. Other wise Netflix is going to have to make some tough decisions going forward.

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Ross Gerber is CEO and president of Santa Monica, Calif-based Gerber Kawasaki Inc., a SEC registered investment advisor with approximately $725 million in assets under management. Gerber Kawasaki clients, firm and employees own positions in Apple, Netflix and Amazon. Readers shouldn’t buy any investment without doing their own research to determine if the investments are suitable to their situation. All investments have risk. Please contact us if you have any questions.