50% Original Content Isn't an Original Idea for Netflix

By Markets Fool.com

Image Source: Netflix.

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Get ready for a lot more original content from Netflix (NASDAQ: NFLX).CFO David Wells told the audience at Goldman Sach's Communacopia conference, "You should expect us to push toward more 50/50 in terms of original exclusive content and licensed content." The move is a long-term bet on the value and longevity of originals on Netflix.

In management's fourth-quarter letter to shareholders for 2014, they highlighted that original content "was some of our most efficient content" from a cost-per-viewing-hour standpoint. More importantly, once Netflix buys an original, it has the rights to stream those shows forever. With licensed deals, Netflix has to renew those licenses every few years when they run out -- often for a higher price.

Becoming even more like HBO

That 50/50 number didn't exactly come out of thin air. It happens to be the same number used by Netflix's chief rival, Time Warner's (NYSE: TWX) HBO.

Last year, HBO spent $1 billion on its original content and sports productions and another $1 billion licensing films for its HBO and Cinemax networks. Netflix doesn't break down its content costs like HBO, but it spends significantly more. For 2016, Netflix expects to spend a total of $6 billion on a cash basis.

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Based on Mr. Wells' comments that "we are a third to halfway through getting where we'd like to be" indicated that Netflix is only spending $1 billion to $1.5 billion of its budget on originals. (That's assuming "50/50" is a description of Netflix's content budget, not its hours of available content. Mr. Well's comment was unclear.)Just a few years ago, in 2013, Netflix's originals budget was around $300 million, so it's not unreasonable to expect Netflix's original content budget to double or triple again in a few years as Mr. Wells suggests.

HBO's success shows how powerful original content can be. Despite only spending $2 billion on content, HBO counts 49 million domestic subscribers between HBO and Cinemax. Internationally, it has 82 million subscribers, but not all of them are premium network subscriptions like in the U.S. Comparatively, Netflix counts 47 million domestic subscribers and 36 million international subscribers despite spending three times as much on content.

The content budget won't be shrinking, though

Wells indicates that Netflix doesn't have any plans to slow down its content spending anytime soon. Unlike HBO, Netflix's aim is to appeal to just about everyone in the world. HBO is a bit more focused with its content. It only recently branched out to kids' programming with Sesame Street.

But with Netflix already spending $6 billion on content and burning through more than $1 billion in cash every year, the company is looking to maximize the efficiency of its content spend. As mentioned, original programming is some of Netflix's most efficient on a cost-per-time-watched basis.

Additionally, originals represent a one-time cost for Netflix. That means that the number of hours of content available on Netflix can continue growing even if its budget doesn't due to the back catalog of originals.

A good show stands up to the test of time, and viewers can watch it again and again. Netflix's entire business is based on that concept. Owning the rights to good shows into perpetuity will help retain and attract new subscribers, and allow for potential price increases in the future. Combining all of those will allow Netflix to start producing positive cash flow for investors.

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Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Netflix. The Motley Fool recommends Time Warner. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.