21 March 2023

    Netflix: winning the streaming wars

    Lily Zhuang (CA)

    Investment Analyst

    Email Lily
    Lily Zhuang (CA)

    Investment Analyst

    Email Lily

    Netflix shares had a tumultuous time in 2022. The end of pandemic restrictions reduced demand for streaming entertainment, competition was peaking, and Netflix subscriber growth turned negative for the first time in a decade. Markets took this as a sign that Netflix had hit its growth ceiling, but this king of content has demonstrated that it is worthy of the throne.

    We added Netflix to the international portfolio last year. In our view, the market had overlooked the company’s strength in content. We also believed the intensely competitive streaming environment was unsustainable in the long term – all streaming providers other than Netflix are losing money.

    Netflix began rolling out paid account sharing and a cheaper ad-supported plan in 2022. These changes allow Netflix to capture more of the value it provides to users and will further improve profitability over time. This contrasts with competitors who raised prices and cut content spend to stem streaming losses as 2022 ended.

    Streaming competition intensified…

    Netflix is the leader in streaming content. It has almost 231 million subscribers in over 190 countries. And on average, each subscriber watches two hours of Netflix a day. Netflix’s competitive advantage is its ability to spend on quality content, scaled across a massive global audience. At the 2022 Emmys, Netflix won 26 of the 105 nominations it received, placing the company second behind HBO / HBO Max. The company expects to spend US$17bn on content this year, dwarfing most of its competitors. Only Disney, Amazon, and Warner Bros Discovery (who now owns HBO) are expected to spend a similar amount or more, but their streaming services have far fewer subscribers than Netflix.

    The COVID pandemic that began in 2020 drove a step change in streaming’s competitive dynamics. Pandemic movement restrictions meant people consumed more entertainment in-home, and they could afford to spend more on that entertainment thanks to higher savings (because they’re staying home), fiscal stimulus and subsidy payments. Consumers had their pick from Disney+, HBO Max, Apple TV+, Amazon Prime Video, Peacock and more. Between 2019 (pre-pandemic) and 2022, the proportion of paying households with three or more streaming services almost doubled from 32% to 58%, according to consumer insights firm Nielsen.

    … but this competition proved unsustainable post-pandemic

    Nonetheless, the situation was clearly unsustainable long term. Elevated savings rates and fiscal stimulus would not last as life returned to normal post-pandemic. For Netflix competitors, being able to fund streaming growth with debt and legacy business cash flows depended on low interest rates and booming demand for streaming entertainment. Altogether, Netflix competitors are estimated to have incurred over $10bn of operating losses in 2022, vs. Netflix’s own $5.6bn of operating profit.

    As 2022 progressed, the post-pandemic “sugar high” in demand receded and a macroeconomic slowdown loomed. Consumer spend shifted away from discretionary goods and services, and companies pivoted from a growth-at-all-costs mentality to focus on profitability.

    Today’s streaming landscape is one of abundant choice. To keep users engaged and making the active choice each month to renew, a successful streaming platform needs plenty of original content released on a regular cadence. Therefore, billions of dollars must be spent on content creation. And Netflix’s own experience shows that the path to streaming profitability takes time. Unfortunately for Netflix’s streaming competitors, time ran out as interest rates rose and investors put greater emphasis on profitability.

    Consider Disney, an entertainment juggernaut with popular content including the Marvel and Star Wars franchises. Disney is Netflix’s closest competitor by number of subscribers. Disney+ has yet to turn a profit since launching in November 2019.

    Coming into 2023, Disney and other Netflix competitors have raised prices, reduced content spend, or both. These actions make them less compelling alternatives to Netflix, and bolster Netflix’s competitive advantage. In the last quarter of 2022, Disney+ lost 2 million users and ended the year with 162 million subscribers, compared to Netflix which added 8 million users and ended the year with 231 million subscribers.

    Long live the king of content!

    We believe Netflix will continue to be consumers’ streaming service of choice. Consumer insights firm Nielsen found that in 2022, 13 of the top 15 original streaming programs were Netflix creations – with Stranger Things, Ozark and Wednesday taking the top three spots. This demonstrates Netflix’s continuing popularity and scale in content creation.

    This year, Netflix is rolling out its ad-supported tier and paid account sharing more broadly as the company cracks down on password sharing. Both options are cheaper than Netflix’s full ad-free plans. We believe this is attractive to the estimated 100 million households globally who use but don’t pay for Netflix. For 60 hours of entertainment a month at the cost of one or two movie tickets, Netflix is compelling value compared to satellite or cable TV. Cable TV has been ceding market share to streaming over time, as shown in the chart below.

    Streaming only represents one third of TV viewership in the US. Streaming share is even lower in the UK (around 16%), and lower still in other countries where viewership is tracked (i.e. in Brazil, Mexico, and Poland). Streaming, and its king of content Netflix, are just getting started.

    If you would like to talk to someone about your investment strategy, the team at Fisher Funds are here to help. Please contact us or get in touch with your adviser.