How Netflix Came Undone
A stock in freefall, erratic management decisions, the Qwikster debacle. How the high-flying envy of Hollywood came crashing down and what it needs to do to regain its mojo, as content producers both fear for the demise of a rich buyer and privately cheer the troubles of an upstart rival.
By almost any definition, Netflix has been the great disruptor of the entertainment business during the past decade. The company has turned more than 20 million Americans into regular consumers of premium streaming video, changed the value proposition for movies and TV shows and helped reshape Hollywood's traditional release windows. And it did this after already having turned the DVD industry into a largely subscription-based business, bringing about the destruction of countless movie-rental storefronts.
It's an impressive résumé that Wall Street rewarded by turning Netflix into a mega-growth stock that surged 500-fold in nine years.
But since July, Netflix has been disrupting mostly its own business with a series of odd strategic moves, prompting the future of the once-envied company to become Topic A among entertainment and technology insiders: a 60 percent price increase for consumers, followed by the spinoff of its DVD-rental business into a separate brand confusingly called Qwikster, then the abrupt demise of Qwikster and finally the late-November announcement by CEO Reed Hastings that Netflix will raise $400 million in a stock-and-debt offering, even though the company insists it doesn't need the money.
At the same time, Netflix still is splurging freely on top-quality Hollywood content, from DreamWorks Animation movies such as Shrek and Puss in Boots to original TV series like David Fincher's upcoming House of Cards to the just-announced resurrection of Fox's cult comedy Arrested Development. Many in Hollywood wonder whether Netflix is overspending, even as studios gleefully cash checks from rich content deals.
Investors, in turn, have punished the stock, which has shed 77 percent in four months, hitting a low of $62.90 on Nov. 25, gutting a staggering $12 billion from the company's market capitalization. Competitors smell blood, and Amazon, Hulu, Google and YouTube, Apple and iTunes and Dish and Blockbuster are circling.
That Netflix has stumbled is obvious. The question is whether it can regain its momentum and whether Hollywood should celebrate or mourn the company's decline in stature, even as Netflix insists its content-acquisition plans remain aggressive.
"There are no signs of us reeling in spending," says Netflix chief content officer Ted Sarandos, who points to recent deals with The CW, AMC and ABC as proof.
Hollywood, in fact, has been feasting at the Netflix trough as the primary beneficiary of its spending. Starz, for example, was negotiating a tenfold increase in the $30 million it had been getting from Netflix annually since 2008, though it couldn't close the deal and Netflix will be without Starz beginning in February. Other TV owners are demanding more for the streaming rights of older content. The assumption is that Netflix will use the $400 million it raises to fund content acquisition, an estimated $2 billion worth in 2012 alone.
"There is legitimate concern that the fountain of money they are paying for content will dry up," says Steve Birenberg of Northlake Capital Management. "Amazon or Hulu or Google need to step up to make it a multi-buyer game."
On Nov. 28, in fact, Standard & Poor's cut its corporate credit rating on Netflix to "BB-" because it was "concerned with the company's escalating content costs and aggressive international expansion plans." S&P said Netflix's content commitments had grown to about $3.5 billion as of Sept. 30, up from $1 billion at the end of 2010.
Netflix has 23.8 million U.S. subscribers -- 21.4 million of whom stream movies and TV shows through the Internet -- and it could afford hefty content deals when it was growing by leaps and bounds. But that might not be the case anymore. In 2010, Netflix grew its subscriber base by 7.2 million, but in 2012 it will add only 2 million subs, some analysts predict.
Much of what analysts say, though, Sarandos dismisses as inaccurate. He says, for example, that Netflix didn't need to raise $400 million to finance content acquisition, and that Wall Street's souring opinion won't keep the company from aggressively negotiating new deals.
"The content budget was well established and continues to be," he says. "It has no bearing on the stock price. The content spend is based on revenue, which is based on subscribers."
Much was made about the inability to strike a new deal with Starz, but that, too, is an overreaction, Sarandos says.
Starz, he says, accounted for 8 percent of streaming viewing hours among Netflix users, but they were asking for significantly more than 8 percent of his budget for acquiring streaming content.
"Just like every negotiation, buyers and sellers disagree on price points, and in this case the ratings equivalent relative to the license fee was completely out of whack," he says.
Even as studios negotiate rich deals with Netflix, some insiders marvel that the company is still willing to spend, given its recent stock troubles.
"They overspent on streaming content," says one television executive who has been on the other side of such negotiations. "What's amazing is, they are still trying to buy their way out by borrowing cash to cover even more content costs."
Some in Hollywood are starting to take the long view, wondering whether the short-term cash flow from Netflix isn't hurting both sides of the equation. "If you watch enough movies [on Netflix], you pay something like 33 cents to see a movie," says a studio exec. "I think movies are more valuable than that. It's a great source of revenue for the studios, but in the long term we're devaluing our assets. [Hastings] had a good game going but now it's a mess."
And one studio insider who loves Netflix nevertheless says it might not recover from the woes that have beset the company in the past four months.
"My guess is they'll sell out to Google or Amazon," he says. "There is a need for them in the public, but the studios don't need them. The studios are going to want more of the money. [Customers] can pay eight bucks a month to watch movies. How much of that eight bucks gets back to the people who make the movies? They will want to price movies by the picture, and that's the end of the Netflix model, which is subscriptions."
Nonsense, counters Sarandos.
"It is business as usual. We have a base of 20 million-plus streaming subscribers and we are licensing content aggressively for them," he says. "Your readers in Hollywood know that because they're on the other side of the table."
NETFLIX STOCK HIGHS AND LOWS
- May 29, 2002: $15: Date of initial public offering
- May 19, 2005: $16.13: Walmart discontinues competing service
- July 13, 2011: $304.79: One day after its maligned price hike is announced
- Sept. 15, 2011: $169.25: Acknowledges the 60 percent price hike will cost it 1 million subs
- Nov. 28, 2011: $69.95: Closing stock price.
- 'Lindsay' Recap: Lohan Attempts Career Comeback With Self-Proclaimed 'New Chapter'
- 'How I Met Your Mother': Cristin Milioti Debunks Morbid Finale Theory (Video)'
- Josh Duhamel to Co-Star in Vince Gilligan's 'Battle Creek'
- A Train, a Trestle and 60 Seconds to Escape: How 'Midnight Rider' Victim Sarah Jones Lost Her Life
- 'Divergent' Star Shailene Woodley: The Next Jennifer Lawrence?
- MOST SHARED
- MOST POPULAR