Netflix (NASDAQ: NFLX) is proving that there is a vast market for digital entertainment out there. Unfortunately the streaming service is also proving that it is also very hard to make money from digital entertainment.
The financial numbers that Netflix reported last week call the whole streaming video product into question. Yes Netflix’s service is growing like a weed it claims it will sell 5.2 million new memberships during the fourth quarter of 2016.
The company’s revenues grew by $551 million during the third quarter indicating that it might be generating more float from all those subscriptions. For the record: Netflix’s revenues rose from $7.625 billion to $8.176 billion between June and September of 2016.
The revenues also grew by $1.735 billion over the year that ended on September 30, 2016. The revenues rose from $6.441 billion at the end of third quarter 2015 to $8.176 billion a year later.
Is Netflix Making Money?
It’s obvious that Netflix’s business is growing spectacularly but it is not making that much from that business.
The company reported a net income of $1.63.11 million and a free cash flow of -$489.31 million on September 30. What was even worse was that Netflix reported a negative cash from operations number of -$1.162 billion, which indicates it is losing money from its day-to-day operations.
That calls streaming video as a standalone business into question. Netflix is capable of reaching a large audience and expanding that audience but not making money from it.
A big reason for this is that Netflix has to give away expensive programming in order to attract viewers. Another is the technological infrastructure that Netflix has had to build to distribute that programming.
Netflix has a Lot of Float
Despite those problems, Netflix does have one thing going for it from a value investor’s standpoint. It has a lot of float, that is a regular stream of revenue from subscription income it can spend or borrow against.
Netflix reported cash and short-term investments of $1.34 billion on September 30. It also reported making $31.7 billion in cash from financing on the same day. That gives Netflix a lot of money to pay with and a lot of growth potential.
Float as we all know can be the key to making a lot of money and building up a vast business empire. Warren Buffett used float from insurance premiums, Blue Chip Stamps, newspaper subscriptions and advertising to build Berkshire Hathaway (NYSE: BRK.B). More recently Jeff Bezos has used float from a variety of sources including Prime subscriptions and Amazon Web Services (AWS) to grow Amazon (NASDAQ: AMZN) into a behemoth.
This means that Netflix has the potential to become the center of a very large and cash-rich organization. It also faces a wide variety of obstacles on its march to world dominance including Amazon.
Netflix’s Uncertain Future
The biggest threat to Netflix out there is Amazon; which reported $120.64 billion in revenue, a market cap of $383.73 billion and cash and short-term investments of $16.54 billion on June 30, 2016. That gives Amazon a vast amount of float that it can throw at video.
The latest example of that float’s uses is the deal Amazon just made with country music legend Garth Brooks. Brooks is planning to stream his music and a live concert from Yankee Stadium through Amazon Music Unlimited, the Associated Press reported.
No financial numbers are mentioned in the articles, but it is obvious that a star of Brooks’ stature does not come cheap. Garth has sold 138 million albums over the years.
A Star System in Streaming Video
The Brooks deal might be the beginning of a new star system in streaming video in which big-time entertainers get huge paychecks and a cut of the gross. The system would function much like that in Hollywood where A-list stars receive astronomical amounts.
Robert Downey Jr. reportedly received $40 million for his role in Captain America 3, Variety reported. Money Nation calculated that Downey might take home $200 million for the next Avengers movie and $430 million for playing Iron Man in various movies by 2019.
One has to wonder how much of Downey’s huge payday is coming directly or indirectly from streaming video. That also raises the possibility that Garth Brooks has been promised a cut of the revenue from streaming audio and video by Amazon.
Naturally it won’t be long before other major stars including rappers, actresses, comedians, actors, and possibly talk-radio and reality TV personalities start demanding similar deals. At least one big star Howard Stern already such a deal, Sirius XM (NASDAQ: SIRI) is reportedly paying the king of all media $90 million a year for his presence on its radio dial. If Howard is worth that much to Sirius, how much would Robert Downey Jr., Daniel Craig, Beyonce, Conan O’Brian or even Dr. Phil might be worth to Netflix?
One has to wonder how Netflix would be able to afford the kind of star power needed to keep its network going. After all, Sirius has a deep pocketed benefactor in the form of John Malone’s Liberty Media Group (NASDAQ: LMCA).
Who Will Buy Netflix?
A major problem that Netflix might face in the future would be a bidding war with Amazon or possibility Liberty for big stars and other major entertainment. Amazon is entering sports another field known for outlandish salaries and huge media deals.
That means that Netflix might not be viable as a standalone future. Its best bet for survival would be acquisition or merger with a larger organization such as Disney (NYSE: DIS) or Walmart (NYSE: WMT).
The obstacle to such a deal is Netflix’s ludicrous share price; $126.68 on October 24, 2016, which gave it a market cap of $55.22 billion. There’s no way Netflix is worth that kind of money it had assets of just $12.35 billion on September 30. I just cannot see Bob Iger shelling out $50 billion for something as questionable as Netflix.
Netflix’s share prices might have to collapse for the company to survive. My prediction is that Netflix will be acquired after its share prices go into freefall which can happen at any time. Netflix has proven that streaming video is a viable business but not necessarily a profitable one.