uploads///Nflx content spend

Why Netflix Plans to Focus on Content in 4Q15

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Oct. 16 2015, Updated 5:06 p.m. ET

Forecast for 4Q15

According to Netflix’s (NFLX) internal estimates, it expects total revenue of ~$1.7 billion for its streaming business and a contribution margin of 15.4% in 4Q15. Netflix expects 5.15 million net additions for its streaming business and 74.3 million total streaming memberships in 4Q15.

Netflix has made an accounting change from 3Q15. Under this change, Netflix will recognize its content licensing costs quicker as an expense on its income statement. It’s going to go for accelerated amortization of its content licensing costs. As a result, a larger proportion of content licensing costs will be recognized as expenses for new shows. The proportion will decrease for older shows. Netflix is doing this to align its expenses with the way Netflix subscribers watch its shows.

This accounting change also means that Netflix’s content expenses are going to increase in 4Q15. This could impact its contribution margin.

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Content spend

Netflix stated that it will likely to go for additional debt next year to fund its content acquisition costs. Netflix had gross debt of $2.4 billion at the end of 3Q15.

Netflix expects to spend ~$5 billion on content acquisition in 2016. Currently, 10% of Netflix’s content spend is on original content. The company would like to raise that to 50% of its total content spend. Netflix believes that original content will strengthen the company’s brand and increase the viewing hours.

According to a Wall Street Journal report citing RBC Capital Markets’ estimates, Netflix could spend $3.3 billion this year on content acquisition. In comparison, Amazon (AMZN) and Hulu are expected to spend $1.7 billion and $1.5 billion, respectively, on the purchase of content in 2015, as you can see in the above chart.

Why focus on original content?

Netflix believes that original content targeted at various user groups will increase the viewing hours and make viewers watch shows repeatedly, turning them into potential subscriber events. This is why Netflix is going for exclusive SVOD (subscription video on demand) rights or second window rights for TV shows and movies.

This was why Netflix refused to renew its Epix deal in August. Netflix wasn’t getting exclusive SVOD rights to Epix movies. It was getting a theatrical window that was behind the window of pay-TV operators. Netflix subscribers would get to watch an Epix movie only after individual pay-TV operators like Dish Network (DISH) aired the movie.

MGM, Lions Gate Entertainment (LGF), and Viacom’s (VIA) Paramount Studios own Epix.

You can get diversified exposure to Netflix by investing in the SPDR S&P 500 ETF (SPY). It holds 0.27% of the stock.

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