Binge-viewing may lead to binge-spending at Netflix, which could eventually see the impact in its stock price.
What went unmentioned among the myriad issues its top execs addressed when the streaming service announced its second quarter earnings last month was a potentially significant shift in accounting practices hinted at in the company’s 10-Q.
“We are in the early stages of original content, and continue to monitor whether the viewing pattern is higher than initially expected in the first few months to suggest that we amortize at a faster initial rate,” the disclosure read.
A Netflix spokesman said the company would have no further comment regarding the disclosure, so here’s a translation: Netflix may need to accelerate spending initially deferred a few years down the road for originals like “House of Cards.”
While that wouldn’t represent an increase in the $150 million Netflix estimates it has spent to date on original series, an adjustment in its payment plan would lower its estimated earnings per share in the near term, according to Barton Crockett, an analyst with Lazard Capital Markets, and that metric has big implications on Wall Street.
“It would create potential for price swings, given that this is a volatile stock, and accounting for content costs is a hotbutton issue,” he noted, emphasizing that the possible swing would have no impact on Netflix’s cash flow or valuation.
Acknowledging “higher than initially expected” viewing in the disclosure is a vaguely euphemistic way of saying Netflix fears a zero-sum game may be at play; the elevated levels of viewing in the early going may be a sign that not as many will watch later in the window of availability.
Crockett theorized that Netflix may have been caught by surprise by how binge-viewing has shaped demand for its original programming. “Netflix might be accelerating front-end loaded viewing by debuting series all at once,” he added.
How’s that for irony: Netflix, which fancies itself a revolutionary in the TV business, may be forced to bring itself in line with traditional industry bean-counting precisely because of its boldest practice.
While studios typically pay the bulk of the license fee for a series over its first year on the air, Netflix adheres to “straight-line” accounting for its original programming expenses, prorating dollars over the life of the license fee. That strategy is related to the company’s rationale for why it doesn’t share audience data: Divulging how the series performs in its opening days is pointless, because unlike TV networks that monetize ratings in the premiere window, Netflix monetizes over the entire run of the series.
It doesn’t matter to Netflix whether a viewer watches “House of Cards” when first released or years later — and the payment plan reflects that.
But as Netflix now seems to be acknowledging, original series don’t perform fundamentally differently on its own platform than they might on a linear channel — which is what’s prompting the reconsideration of expenditures. Costs that might otherwise be smoothed out across four years get lumpy over the next two, though lower than expected in 2015 and 2016.
For example, Crockett estimates that “Orange Is the New Black” cost $52 million for its first season. What might otherwise amount to $5.2 million spent over the remaining quarters of 2013 would balloon to $13 million with accelerated amortization. Across Netflix’s entire original slate, an investment that would amount to spending $41 million in 2013 turns into $106 million.
As Crockett sees it, Netflix may have mistakenly thought consumption of its original programming would mimic that of its library content. “But we believe there’s a big difference between putting up a previous season of ‘The Walking Dead,’ and a new season of ‘House of Cards,’ ” he says.