Just a few months after Walt Disney's (NYSE: DIS) exclusive streaming deal with Netflix (NASDAQ: NFLX) began, it's coming to an end. Disney announced its plan to end its relationship with Netflix in 2019 to start its own direct-to-consumer streaming product.
The represents a major blow to Netflix, which has spoken highly of Disney's content library. "Disney makes big franchise films. The movies that people like to watch over and over again," Chief Content Officer Ted Sarandos said last year.
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More importantly, it could be the start of a sea change for Netflix's content licensing business, which relies on other media companies. Other media execs, such as Time Warner's (NYSE: TWX) Jeff Bewkes, have expressed their concern that licensing shows and movies to Netflix is negatively affecting the results of their television ratings and movie sales. Some may decide to follow in Disney's footsteps, destroying some of the value of a Netflix subscription.
The shift away from Netflix
Media companies have a love-hate relationship with Netflix. Netflix provides a strong source of revenue, but it's also responsible for taking away viewership from traditional television. If viewers can get everything they want from Netflix, there's no need to subscribe to cable, no need to tune into broadcasts as they're happening, and certainly no need to watch advertisements.
As such, it's caused several media companies to rethink their relationship with Netflix. Disney is only the latest. Time Warner expressed the desire to push its licensing window back nearly two years ago. It wants to retain the rights to its content for several years instead of a few months before it lands on Netflix.
CBS (NYSE: CBS) launched its own streaming service nearly three years ago: CBS All Access, which competes for attention with Netflix and traditional cable subscriptions. Interestingly, CBS is using Netflix to syndicate its new All Access Star Trek original series everywhere globally except the United States. Still, CBS is increasingly reserving its best content for its own streaming service in the U.S.
Disney's decision to retain control of its own movies is just the latest move from big media companies. It likely won't be the last we see.
Smaller media companies may stick with Netflix to benefit from the increased exposure of the streaming platform and its 100 million-plus subscribers. But major networks and film studios with differentiated content like Disney won't stick around forever if Netflix continues to steal away their audiences.
Putting pressure on Netflix originals
Netflix's content budget has ballooned in recent years as it expanded globally and ramped up original productions. The company expects to spend $6 billion on content in 2017. As it starts footing the bill for more originals, producing them in house, Netflix is burning about $2 billion in of cash every year.
But don't expect the loss of content licensing deals to lighten up Netflix's investment in content. On the company's first-quarter earnings call, CFO David Wells said that even if content cost less, it would just buy more content to fill the budget.
On the other hand, if media companies like Disney demand more money for their content, Netflix's budgetary constraints would force it to take less content. Netflix may see that play out as it's currently in discussions to retain Disney's Star Wars and Marvel content beyond 2019.
But Netflix's content doesn't have to be specifically from Disney, or Time Warner, or CBS, or anyone, as long as it does a good job of filling the audiences those media companies' content attracts.
That puts a lot of pressure on Netflix to continue hitting the mark on original content. "That's why we got into the originals business five years ago, anticipating it may be not as easy a conversation with studios and networks," Sarandos recently told Reuters. It's done an excellent job so far, but it also needs to take more risks, which it's just starting to do four years into its original content strategy.
The loss of Disney will sting, but Netflix has a couple of years before it needs to replace that great content with its own. Netflix's original content machine has a new target, and with its recent acquisition of Millarworld, it now has some interesting intellectual property to play with.
That said, this will put even more pressure on Netflix's free cash flow, which the company expects to come in between negative $2 billion and negative $2.5 billion this year. Originals -- especially originals produced in house -- cost a lot more upfront than multiyear licensing deals. As such, Netflix may have to tap the bond market once again to raise cash if it loses a lot of licensing deals and replaces them with original content.
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Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Netflix and Walt Disney. The Motley Fool recommends Time Warner. The Motley Fool has a disclosure policy.