Disney has since reported interim results covering the six months to the end of March 2018, with pre-tax profit staying broadly flat despite a 6% uplift in revenue and a big improvement in free cashflow.
Much of the hype around Netflix centres on its operational progress, placing a lot of pressure on the company to keep expanding and growing its customer base. The recent highs have been spurred on by Netflix’s first quarter (Q1) results for 2018, showing a 43% year-on-year jump in revenue – representing the fastest pace in its history. That was driven by a 25% lift in memberships and a 14% rise in its monthly subscription price, which also helped to improve its operating margin.
On a net basis, Netflix added over seven million subscribers in the first quarter of 2018 alone, over one million more than the company expected and over 50% higher than the year before. The performance in the important US market was better than anticipated after tinkering with its pricing, and its international division (encompassing virtually everywhere else apart from China) continues to flourish with the division now accounting for more than half of all revenue and 55% of total memberships.
Netflix share price climbs to new all-time highs
Netflix shares recently climbed to an all-time high of $353.54 to give it a market cap of over $155 billion.
Disney share price fails to find new ground
While its performance in the first half of its financial year showed improvement, Disney shares have been giving back as much ground as they find over the last year or so.
Disney’s new streaming services to rival Netflix
Disney is a diversified media giant and is used to sharing its content (obviously at a price) with others in the industry, including the likes of Netflix. However, the company is aware of the fundamental shift happening in the industry and is responding in a way that will make it become a direct competitor with its partner.
Disney is doing the reverse of what Netflix is doing, sending them on a collision course. Just as Netflix is not content with broadcasting third-party content and producing its own programming, Disney is not satisfied just producing content for others, and is looking to eradicate the middleman between its productions and the general public.
Disney is launching two direct to consumer streaming services, one this year and another in late 2019. The first is built around the ESPN brand offering streamed sporting events and therefore not a direct threat to Netflix, which has said it would only look at streaming live sports when it has a spare $10 billion in the bank. However, that first service will help bolster the attractiveness of the second service, planned for next year, which will directly compete with Netflix. This will leverage its core brand, streaming its television and film content. Importantly, much of this content is currently licensed out to Netflix, but Disney is preparing to remove a large chunk of its content when the current deal expires to shift it onto its new platform.
The multi-billion dollar battle for content
This, in turn, is helping to fuel the battle for content. Netflix started producing its own content back in 2012 as it looked to reduce the amount it was paying for third-party content and this model has expanded rapidly since.
The company will spend between $7.5 billion to $8 billion this year on original content, from low-budget indie films to $100 million blockbusters, and that is bearing in mind that the costs of making its own programming is spread over several years. About 85% of new spending is channelled to original content with hundreds of programmes being added this year, and by the end of 2018 there will be over 1000 original productions on Netflix’s platform.
Additionally, it plans to spend around $1.3 billion on technology and development this year to demonstrate it is a tech-firm, not just a service provider.
But this spending spree is being funded by debt, and the pile is growing. It plans to spend $3 billion to $4 billion more than it generates this year – meaning that up to half of its budget is being funded by debt. It recently raised $2 billion worth of debt, the biggest single sum taken out to date and the second time it has been to the bank in the past year, and total debt and liabilities on its balance sheet stand around the $30 billion mark.
Netflix uses Disney as a prime example of why it needs to spend so much on original content, arguing it has to invest in its own programming as content providers start to pull their own from its platform. If there are concerns now about how Netflix is using debt to fund its ambitions then investors should prepare for long-term anxiety as the company is forecasting negative free cashflow for ‘several more years’.
The Disney-branded streaming service will only appeal to certain Netflix customers. However, Disney has another service that could ramp-up the competition even further.
Hulu: Disney and Comcast vie for Fox’s entertainment assets
Comcast is extremely similar to Disney on paper – it has a rival broadcast network, a portfolio of entertainment and news channels and the well-regarded filmmaker Universal Studios, including two of its own animation studios Illumination and DreamWorks. Comcast even has theme parks.
Comcast and Disney are used to being partners but rivalry is currently taking precedence. Disney is trying to buy Twenty-First Century Fox's stake in UK broadcaster Sky and Star of India, cable channels like National Geographic and a slew of regional cable channels mostly dedicated to sport. It also includes the 20th Century Fox studio as well as a highly active television studio. But Comcast also wants the studios and overseas broadcasters (and has even placed a rival bid against Fox for the last piece of Sky that Fox does not already own).
The deal has wider ramifications for the industry however it turns out, but for Netflix the concern will be focused on Hulu. Comcast, Disney and Fox currently own equal stakes in Hulu, a TV and film streaming service that tweaks certain elements of the Netflix business model, offering ad-supported services as one example. Although both are trying to get hold of some other key assets from Fox, Hulu is an integral part of the deal as whoever wins gets majority control over the closest thing to a rival to Netflix and its big competitor Amazon.
China: the final frontier for Netflix
Netflix has managed to break into virtually every major market in the world, active in 192 countries. One reason for its success overseas has been its attention to native languages, acquiring local content and studios to attract non-English viewers. In turn, it has found a market for foreign-language films in English speaking markets.
However, China is the last stop for Netflix. Having spun off from Chinese giant Baidu and listed on the NASDAQ earlier this year, iQiyi is the dominant video streaming platform in China. China’s laws on foreign companies operating in the country twinned with iQiyi’s dominance has prevented Netflix from entering thus far, much like Alibaba Group (which has its own services rivalling iQiyi) has staved off competition from Amazon in the online shopping space.
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Although iQiyi is a streaming service and understandably seen as the Chinese version of Netflix, the company believes it is in fact more comparable to Disney. Founder and chief executive, Tim Gong Yu, recently told the South Morning China Post that the company was aiming for vertical integration, aiming to create an ecosystem of characters and brands, rather than the horizontal expansion that has seen Netflix spread internationally.
iQiyi understands that Chinese content cannot be pushed overseas in the same way Netflix pushes its predominantly English content. Quite simply, iQiyi wants to become the national entertainment symbol of China, like Disney is in the West and companies like Nintendo in the East.
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Conclusion: the future of these companies
Those that doubt Netflix’s future focus on three main concerns: maintaining growth, debt, and the existing and emerging competition. The company has reaped the reward of its first-mover advantage in the streaming space but now it needs to keep it.
Disney’s decision to leverage the strength of its brand and take its content directly to the consumer represents a much bigger paradox for the wider media and entertainment industries. If others follow Disney then these subscription streaming services will all be focused on their own original content as studios look to lean on their own productions – justifying Netflix’s rampant spending on its own programming. This idea is not necessarily contained to TV and film – the music streaming market dominated by Spotify and Apple could be equally as vulnerable (think of Jay Z’s Tidal service).
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Even if Netflix’s spending is justified, investors are questioning whether it’s sustainable. Is Netflix spending to dominate over the coming years, or is this just the start of an ever-ballooning budget for years to come?
Still, investors considering Disney need to take into account the multiple possibilities that could come from talks with Fox. The deal has already been dragged out since December last year and Comcast is only just starting to prepare its formal bid, which is expected to offer a premium to that of Disney’s offer. In addition, regulators (including those in the UK probing the Sky deal) are keeping a close eye on proceedings and will not let any deal go through lightly. Importantly, whichever company wins the bidding war, Comcast or Disney, will take on a considerable amount of new debt in order to complete the deal and prepare for a lengthy integration process.
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