A New Business Model

• Switch from DVD to streaming and international

expansion:
– Marketing implications:
• Customer backlash over the split and price increase.
– Operating implications:
• Infrastructure (from logistics to technology)
• Content acquisition (different rights)
– Reporting implications:
• Amortization of streaming content vs. DVDs
• Timing and uncertainty of content recognition
– Financing implications:
• How to finance more expensive content and subscriber
growth in new markets?
 Content Amortization
• DVDs:
– 1 (for new releases) to 3 (for back-catalog) years
– Accelerated (sum-of-the-month) amortization
– Combination of customer interest and disc durability
– Generally sold at a loss (c.f. Exhibit 3a, “Gain on disposal of DVDs”)

• Streaming:
– 3 to 5 years amortization based on contract length.

• Shift to streaming  lower amortization expense (relative to

content library).
• The question is whether the change in amortization is legitimate,
i.e., whether it reflects the true underlying economics of the
business, or whether it is an attempt to boost earnings artificially.
 Content Recognition
• Streaming content subject to FAS 63:
– Three criteria to determine if content qualifies as an asset or not.
– A significant portion of Netflix’s content not recognized right away because
one or more of the criteria is not met, but mentioned in footnotes.
– The amount disclosed in the footnotes is a lower bound on future
commitments.

• Netflix is just applying the accounting standard, and being

transparent about it (c.f. slide deck on their website to illustrate FAS
63).

• The key issue, from an analysis standpoint, is to use all of the

information available to assess Netflix’s growth and its ability to
finance that growth (internally or with additional debt/equity).
 Subscriber Base
1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 […] 1Q16

Domestic Streaming
23.4m 23.9m 25.1m 27.1m 29.1m 29.8m … 47.0m
Subscribers
International
Streaming 3m 3.6m 4.3m 6.1m 7.1m 7.7m … 34.5m
Subscribers
Total Streaming
26.5m 27.6m 29.4m 33m 36m 37.5m … 81.5m
Subscribers
Domestic DVD
10m 9m 8.6m 8.2m 8m 7.5m … 4.7m
Subscribers

Total Subscribers 36.5m 36.8m 38m 41.5m 44m 45m … 86.2m

 Financial Performance
1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 [...] 1Q16

Sales growth 21.0% 12.8% 10.1% 8.0% 17.7% 20.3% … 7.4%

ROS (0.5%) 0.7% 0.8% 0.8% 0.3% 2.8% … 1.4%

Asset turnover 1.1x 1.0x 1.0x 1.0x 1.0x 1.0x … 0.2x

Total debt/Equity 63.0% 60.6% 55.8% 58.0% 86.1% 45.2% … 102%

ROE (2.8%) 3.6% 4.4% 4.3% 1.4% 12.3% … 1.2%

 Netflix – Managing Content
• Content acquisition:
– New streaming deals (e.g., DreamWorks for 300 hours of
original programming starting 2014; Exclusive US
subscription service for first-run films from Disney, Walt
Disney Animation, Marvel, and Pixar starting in 2016)
– But also lost some deals (Showtime Networks which feared
a loss of viewer base; Starz)
• Developing own content:
– Mostly US content so far (House of Cards, Orange is the New
Black, etc.)
– Non-U.S. content to match global expansion (e.g., Marseille)
Netflix Stock Price
July 2010—June 2016
Netflix – What’s Next?