We may soon find out just how ad­dic­tive Net­flix can be

The whole world is switch­ing on to Net­flix, but an in­creas­ingly crowded mar­ket could ham­per its growth, writes James Tit­comb

The Sunday Telegraph - Money & Business - - Front page -

Last week, re­ports emerged of what may be the world’s first case of Net­flix ad­dic­tion. A 26-year-old man in Ban­ga­lore, In­dia, checked him­self into a clinic claim­ing he had suf­fered fa­tigue and eye strain through months of com­pul­sive binge-watch­ing.

It is some­thing many of us could re­late to. The video-stream­ing be­he­moth, which has had hit af­ter hit with glossy TV shows such as Stranger

Things and Orange is the New Black, has eaten up so many hours of sub­scribers’ lives that there is seem­ingly lit­tle time left in the evening for it to con­quer.

Reed Hast­ings, Net­flix’s chief ex­ec­u­tive, is fond of say­ing many users only tune out when it is well past bed­time. “You get a show or a movie you’re re­ally dy­ing to watch, and you end up stay­ing up late at night,” Hast­ings said last year. “We ac­tu­ally com­pete with sleep. And we’re win­ning!”

Win­ning is some­thing Net­flix is used to. The com­pany, founded as a DVD rental ser­vice 21 years ago (it only started let­ting users watch shows over the in­ter­net in 2007 and it was not un­til 2011 that stream­ing con­trib­uted the ma­jor­ity of rev­enue) has taken a seem­ingly unas­sail­able lead in the on­line TV mar­ket.

In the UK, 28pc of peo­ple say they have used the ser­vice in the last month. The com­pany’s sub­scribers watch an av­er­age of 50 min­utes of Net­flix a day, and the ser­vice ac­counts for 15pc of the world’s in­ter­net traf­fic, more than any other ser­vice.

Among younger view­ers, Net­flix sim­ply is TV: sur­veys show that more 12 to 15-year-olds in Bri­tain have heard of it than BBC One.

The Queer Eye-maker has also been a sen­sa­tional stock-mar­ket story. Shares have mul­ti­plied a hun­dred­fold in the last 10 years, a re­turn closer to Bit­coin than for a com­pany of its size. This year, it briefly sur­passed Dis­ney as the world’s big­gest me­dia com­pany.

The com­pany’s ex­tra­or­di­nary rise, and in­vestors’ be­lief in it, can be traced to two mo­ments. The first was March 2011, when the com­pany that had long re­lied on li­cens­ing TV com­pa­nies’ shows ven­tured into orig­i­nal pro­gram­ming, buy­ing the rights to the po­lit­i­cal thriller House

of Cards. Its cat­a­logue has swelled to hun­dreds of ti­tles. The sec­ond came in 2016, when overnight the ser­vice was switched on in ev­ery coun­try around the world, bar a cou­ple of ex­cep­tions (it is not avail­able in China, al­though it re­tains am­bi­tions there, or Crimea, Syria and North Korea due to US sanc­tions).

It cat­a­pulted Net­flix from a stream­ing com­pany into a world­wide ser­vice akin to Face­book or Google, with a po­ten­tial mar­ket of bil­lions. “You are wit­ness­ing the birth of a global TV net­work,” Hast­ings said at the time.

“In a very short pe­riod of time, Net­flix has be­come a global brand,” says Paolo Pesca­tore, an in­de­pen­dent tech and me­dia an­a­lyst. “It is the first truly global sub­scrip­tion video-on-de­mand provider.”

Much of the world is still to be con­quered. It was only this year that the num­ber of peo­ple who sub­scribe to Net­flix out­side the US sur­passed those in its home coun­try. Its 130m pay­ing cus­tomers rep­re­sent a frac­tion of the mar­ket.

But some de­tect signs that Net­flix’s rise to great­ness is far from guar­an­teed. “I don’t be­lieve the fu­ture is as bright and rosy as peo­ple think,” says Pesca­tore.

Net­flix is of­ten grouped in a clus­ter of gi­ant tech com­pa­nies – the “FANGS”, along with Face­book, Ama­zon and Google’s par­ent com­pany Al­pha­bet – that have come to sym­bol­ise the tech boom. All four are val­ued far higher than one would ex­pect given their prof­its, but Net­flix is a spe­cial case. Its $142bn (£107bn) val­u­a­tion is 56 times 2020’s fore­cast earn­ings. The next clos­est is Ama­zon, at 47 times fu­ture earn­ings; Face­book and Al­pha­bet sit around 20 times. Net­flix in­vestors are re­ly­ing on many years of break­neck growth, as is the com­pany. It has em­barked on a stun­ning in­vest­ment in con­tent since its orig­i­nal bet on House of Cards, and com­mit­ted to pay­ing $18.4bn over the next five years, a sum that is ex­pected to con­tinue to rise.

Op­er­at­ing prof­its are still rel­a­tively low, and the com­pany is burn­ing through cash – up to $4bn this year alone – so the com­pany re­lies on bor­row­ing to fuel its huge in­vest­ment in orig­i­nal ma­te­rial. Long-term debt has tre­bled in the last three years, from $2.4bn to $8.3bn in June. It has been cheap and easy, too. In April, the com­pany bor­rowed an­other $1.9bn in its big­gest fi­nanc­ing ever.

In other words, Net­flix’s stock­mar­ket boom over the last few years has been ac­com­pa­nied by a cy­cle of higher growth, more spend­ing and cheap bor­row­ing. That is fine, and the com­pany has de­liv­ered. But the slight­est sign that things are not go­ing to plan meets a tu­mul­tuous re­ac­tion.

In July, the com­pany’s shares slumped af­ter Net­flix slightly missed in­vestors’ growth ex­pec­ta­tions. Sub­scriber num­bers grew by 5.2m in the sec­ond quar­ter of the year – an im­pres­sive fig­ure, but a mil­lion be­low fore­casts – lead­ing shares to drop by 14pc. It pre­dicted growth would be slower in the third quar­ter and will re­veal re­sults on Tues­day.

A rout of tech-com­pany shares last week hit Net­flix par­tic­u­larly hard. Ris­ing yields from govern­ment bonds threaten to push up the com­pany’s cost of bor­row­ing. It was with tricky tim­ing, then, that David Wells, the chief fi­nan­cial of­fi­cer, an­nounced he was leav­ing af­ter eight years.

Net­flix shares have now fallen by a fifth since their peak in July, al­though af­ter their me­te­oric pre­vi­ous rise, they

are still up 70pc this year. “I don’t think any­one at Net­flix is watch­ing stock-mar­ket moves,” says Rich Green­field, an an­a­lyst at BTIG Re­search.

More con­cern­ing could be the threat the com­pany faces as tech­nol­ogy and me­dia com­pa­nies charge up ri­val ser­vices. Ama­zon’s Prime Video ser­vice is grow­ing rapidly, and the com­pany has shown it­self to be just as will­ing to spend heav­ily, if not more so. Ama­zon is us­ing video to en­cour­age peo­ple to sign up for its de­liv­ery sub­scrip­tion ser­vice Prime, so is un­der less pres­sure to make money from it.

To date, Ama­zon and Net­flix have co­ex­isted peace­fully – many house­holds are happy to take two in­ter­net TV ser­vices – but what about three, or four? Ap­ple has spent years gear­ing up for a push into on-de­mand video, and while its plans re­main closely guarded, ru­mours sug­gest it is pre­par­ing to of­fer its shows for free to those who buy its hard­ware.

The big­gest chal­lenge may lie in Dis­ney, how­ever. The me­dia gi­ant handed Net­flix a huge boost six years ago when it inked a deal with the com­pany in an age where stream­ing was still tiny, but last year it vowed to pull its ma­te­rial and launch its own by the end of 2019. Fresh from its ac­qui­si­tion of 21st Cen­tury Fox, it boasts a for­mi­da­ble li­brary of ma­te­rial, from Star Wars to the Mar­vel su­per­hero em­pire, and has promised to beat Net­flix on price. Last week, Warn­er­me­dia, the At&t-owned me­dia gi­ant be­hind the Amer­i­can net­work HBO, an­nounced plans to build its own stream­ing ser­vice. “The mar­ket’s al­ready look­ing very crowded from a sub­scrip­tion point,” says Richard Broughton, of Am­pere Anal­y­sis.

But while none of the en­trants are likely to top­ple Net­flix, they could ham­per its growth. Broughton says that if sub­scriber growth starts to slow down, in­vestors’ fo­cus will shift to how much it is able to raise prices.

The com­pany has in­creased the prices it charges sub­scribers – the most ex­pen­sive pack­age in the UK costs al­most dou­ble what it did when it launched in Bri­tain – but not enough to keep up with pro­duc­tion bills.

Con­tent costs will con­tinue to rise, es­pe­cially in Europe, where the EU is set to de­mand al­most a third of the cat­a­logue be­ing pro­duced lo­cally.

Broughton es­ti­mates the com­pany could eas­ily in­crease the cost of its sub­scrip­tions by 50pc without los­ing too many cus­tomers, given its suc­cess in rais­ing prices to date.

Such a move is un­likely to be pop­u­lar. It may also be the test of just how ad­dic­tive Net­flix can be.

‘In a short pe­riod of time, Net­flix has be­come a global brand. It is the first truly global sub­scrip­tion video-onde­mand provider’

‘The mar­ket’s al­ready look­ing very crowded from a sub­scrip­tion point of view’

Net­flix has ploughed bil­lions into shows such as, clock­wise from left, The Crown, Orange is the New Black and Ma­niac, but finds it­self lead­ing an in­creas­ingly crowded TV stream­ing mar­ket­place

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