Netflix vs. Disney vs. Google what is the Future of Entertainment?

There is a savage battle for the future of entertainment in progress that every investor, artist and consumer should pay careful attention. It is the conflict between the old model of entertainment characterized by The Walt Disney Co. (NYSE: DIS) and the new paradigm exemplified by Netflix (NASDAQ: NASDAQ: NFLX).

The old model is that a few large companies offer the public a limited number of entertainment choices; that executives or creators feel will have mass appeal. One company creates all the programming and controls it. Disney famously maintains rigid control over its brands, and often goes out of its way to limit choices.

Disney exemplifies the old model with its TV networks, movies and theme parks. The choices are limited; but they are highly profitable – because they are the most popular. Disney gets to maximize profits because it owns the brands; and controls any means of cashing in on them.

The new model is an open-sourced platform offers consumers a wide variety of choices. The programming is created by many different providers and the platform has little or no control. Netflix commissions some programming; but it makes most of its money from subscriptions based on the sale of access to a wide variety of programming.

So which of these models is best from an investment standpoint? Which model will survive the test of time and make money.

Disney Makes Money, Netflix does not

From a straight value investment standpoint, Disney’s business model is far better. The Magic Kingdom is making far more money than Netflix; Disney reported a net income of $8.99 billion on December 31, 2016. Netflix reported $163.1 million on September 30, 2016.

Netflix is also burning through a lot of cash it reporting $1.162 billion in cash from operations on September 30, 2016. Disney generated $12.02 billion in cash from operations on December 30, 2016. That gave Netflix a “free cash flow” of -$489.31 million on September 30, 2016. Disney reported a positive free cash flow of $220 million on December 31, 2016.

It looks as if Netflix is close to running out of money. It might need to find a deep-pocketed buyer or benefactor; such as Disney, simply to survive.

Netflix’s Business Model Might Not be Viable

This indicates that Netflix’s newfangled business model might not be viable. One major problem that Netflix faces; and has failed to address, is that it has a massive competitor; YouTube, which is giving away programming for free.

A person with a decent internet connection can get a vast amount of video entertainment (Netflix’s product) free on YouTube. Netflix is trying to build a massive world distribution system for digital entertainment, Alphabet (NASDAQ: GOOG) has already built that system and gives anybody access to it for free.

The numbers show that Google’s open-sourced business model is better than Netflix’s subscription scheme. Alphabet (NASDAQ: GOOGL) reported a net income of $19.48 billion, a free cash-flow of $6.335 billion and $36.04 billion in cash from operations on December 31, 2016 according to ycharts. That indicates the combination of open sourced programming and advertising has far more potential than Netflix’s subscriptions.

Obviously Alphabet has many other sources of revenue, but that too presents a problem for both Netflix. Netflix effectively has only one potential source of revenue: subscriptions. Google and Disney can rake in cash from a variety of sources; Disney has licensing and theme parks to generate additional cash from its brands.

Another dilemma Netflix faces is that Disney effectively makes money off of it. Netflix buys programming from Disney and promotes Disney brands; such as the Marvel Superheroes, in the process.

This means that the only future for Netflix might be as part of a larger organization such as Disney. Digital video might remain a sideline business for larger organizations such as Amazon (NASDAQ: AMZN) and Alphabet.

Disney’s Dilemma Market Shrinkage

Disney’s dilemma is not lack of money but of market share shrinkage. Old-school entertainment combines such as Disney depend upon easy access to a mass market. Disney uses its TV networks such as ABC and ESPN to promote its brands.

The viewership of NFL games on ESPN; a reliable advertising cash cow for Disney, dropped by 8% during the 2016 regular season, ESPN itself admitted. The typical NFL game on ESPN lost 1.4 million viewers between 2015 and 2016. What is happening at ESPN is typical of TV ratings.

The mass market has started to shrink and it is affecting Disney’s revenues. Disney’s revenues hit a high of $56 billion in June, 2016; but fell to $55.17 billion by December. During the same period Netflix’s revenues continued to grow rising from $7.625 billion in June, to $8.176 billion in September.

All this means that Disney will have to learn to live with a smaller audience and fewer revenues, or find new audiences. One obvious means for finding new audiences would be to buy Netflix; which has a global digital entertainment distribution platform Disney can use to reach new audiences.

Both entertainment models work but they each have serious drawbacks. Netflix has not figured out how to make its model pay; while Disney is unable to protect its market share. The data suggests that a combination of new and old models would work best.

The question investors need to ask is: which company will create that hybrid? My suggestion would be Disney; because it has the resources to do so, although it will face aggressive competition from Amazon. Investors can be certain of one thing – the entertainment landscape will soon change beyond recognition.